Sidestepping Windstream, Level 3 Might Make 11th Hour Bid for PAETEC

By Josh Long

PAETEC Holding Corp. is well into its merger agreement with Windstream Corp., but a financial analyst last week raised a question that makes PAETECs future seem less certain. Would Level 3 Communications, fresh off its acquisition of Global Crossing, submit an unsolicited bid that PAETECs board of directors would have to consider?

In a research note Oct. 6, FBR Capital Markets & Co. analyst David Dixon said Level 3 would be justified to offer a higher bid than Windstream.

While the WIN/PAET deal makes sense from a defensive perspective and offers some synergies, an LVLT/PAET deal makes greater strategic sense from a scale perspective and we believe creates more upside for both LVLT and PAET shareholders due to even higher synergies from their overlapping network coverage and operations,” the analyst wrote.

Spokesmen for Level 3 and PAETEC declined to comment on the report.

PAETECs shareholders are scheduled to vote on the Windstream merger on Oct. 27 in New York. But PAETEC revealed in its proxy statement/prospectus that it may terminate the merger agreement if PAETEC has received a proposal that its board of directors determines in good faith to be superior to the merger and certain other conditions are met, including PAETECs provision to Windstream of notice of such a proposal and an opportunity to revise the terms of the merger agreement.”

PAETEC, whose stock price has climbed since the Windstream merger was announced Aug. 1, would have to pay Windstream a $40 million termination fee.

Hostile takeovers are rare, and there is much market uncertainty but at current valuation, LVLT could present a topping bid to the board of $7.30 per share and should be able to retain 50% of synergy upside,” Dixon wrote.

PAETEC Shares Up

On Aug. 1, Windstream revealed an agreement to acquire Fairport, N.Y.-based PAETEC in a deal valued at $2.3 billion. Windstream said it expected to issue 73 million shares of stock valued at $891 million and assume or refinance debt of $1.4 billion at the time of closing. PAETEC shareholders will receive .460 shares of Windstream common stock for each PAETEC share. That represents a roughly $5.93 value for each share of PAETEC common stock based on the closing price of Windstream s common stock on Sept. 16, according to Chairman and CEO Arunas Chesonis, in a letter last month to shareholders.

On July 29, 2011, the last full trading day prior to the merger announcement, PAETEC’s stock closed at $4.41 per share. Windstreams stock price was $12.21 per share. Since the merger, PAETEC’s stock price has risen while Windstreams stock has gone in the opposite direction. Shares of PAETEC (PAET) closed today at $5.38, up 5 cents or 0.94 percent on the NASDAQ. Shares of Windstream (WIN) closed at $11.42, up 18 cents or 1.6 percent on the NASDAQ.

PAETEC and Windstream are well into their merger: The companies anticipate closing the deal by the end of the year. The companies have received little public opposition to the merger at the Federal Communications Commission, although the City of Rochester, N.Y., objected to the deal last month in an FCC filing.

Little Rock, Ark.-based Windstream provides high speed Internet, voice and digital TV services to residential customers in 29 states. As of June 30, 2011, the company served roughly 3.3 million access lines and 1.3 million high-speed Internet customers. The business-oriented PAETEC provides services in 48 states and the District of Columbia to roughly 53,000 business customers based on second-quarter results.

Other Interest in PAETEC

Windstream has not been the only company to express interest in buying PAETEC. In its proxy statement/prospectus, PAETEC disclosed that another company indicated it was prepared to offer between $5.45 and $5.75 per share of common stock in a stock and cash deal, consisting of 80 percent common stock and 20 percent cash. PAETEC did not reveal the name of the company. In his research note, however, Dixon mentioned a $6.80 per share (with 20 percent cash) offer from Earthlink that PAETEC rejected.

Despite the progress of the Paetec-Windstream merger, Dixon indicated that Paetecs board couldnt ignore a generous bid by Level 3.

We believe the upside for PAET shareholders is significant enough the board would have to seriously consider a substantial premium bid from LVLT .,” Dixon said.

Last week, Level 3 announced closing its acquisition of Global Crossing, creating a global communications carrier with 2010 pro forma combined revenues of $6.2 billion and fiber infrastructure on three continents in more than 45 countries.