By Khali Henderson

In a three-way transaction billed by the participants as a next-generation CLEC, Speakeasy, a Best Buy company (BBY), has entered into an agreement to combine its business with Covad Communications Co. and MegaPath Inc., two competitive service providers that in March announced plans to merge. The combined privately held company is expected to have annual revenues greater than $500 million.

The Speakeasy transaction is contingent upon the MegaPath and Covad deal, which is expected to close in the third quarter of 2010. Financial terms were not disclosed. Best Buy, which acquired Speakeasy in 2007, will continue to be a minority investor going forward.

This transaction will combine Speakeasys small business voice and data services with MegaPaths services for distributed enterprises, and make them available over Covads nationwide broadband network.

Upon closing, the companies plan to continue to serve the market through two divisions: a wholesale operating division and a direct, commercial division most likely Covad and MegaPath, respectively, but branding may change when the deals close. MegaPath CEO Craig Young will become executive chairman of the combined businesses. Covad CEO Pat Bennett will continue in that role, managing the wholesale business, and reporting to Young. Bruce Chatterley, CEO of Speakeasy, will be president of the commercial unit in charge of all non-wholesale customer sales and marketing division.

Initial reaction from the analyst community is that the deal makes sense in terms of synergies among the three service providers, but that it also presents an opportunity for Best Buy to pull back from what may have been an ill-conceived step into the service provider business.

Analyst Donna Jaegers, senior analyst, telecom services for D.A. Davidson & Co., for one,  said, its very possible the big box retailer wanted to step back, noting that Speakeasy does not make much money for Best Buy and to take it to the next level would have required a greater investment and that selling might be an easier route. I was surprised that Best Buy would buy [Speakeasy] in the first place, she said.

Judy Reed Smith, CEO of Atlantic-ACM, agreed, noting that it appears Best Buy didnt make a success of its acquisition of Speakeasy if it bought the company in 2007 and its dumping it already. They must believe someone else, like service providers Covad and MegaPath, may be better at it.

Larry Hettick, research director for Current Analysis, agreed. It didnt make a whole lot of sense for Speakeasy to be part of an electronics retailer, he said. Service providers are best managed in a service provider environment and not by a consumer-oriented hardware supplier.

Dan Foster, chief sales and marketing officer for MegaPath, countered that while Best Buy is a minority investor, it is participating in a much larger venture and, therefore, growing its interest in the telecommunications space.

The bottom line is as the industry consolidates, scale becomes more  important both in the product depth and in the size of your business and the size of your talent tool. What I think Best Buys interest is is helping us achieve that scale by continuing to keep one foot in and being at the table to learn and understand how business customers buy these types of services, said Chatterley.  Their strategy for the future is rooted in the belief that there is something called the connect world coming and some of us believe is already here where every device that they sell is connected to something. This gives them the opportunity to develop their knowledge base and their strategy around how that connected world operates in the business market while allowing us as a business to achieve the scale and the product breadth and growth we need to succeed.

Analyst Craig Clausen, executive vice president for New Paradigm Research Group, is doubtful that the Best Buy investment will be an advantage to the new CLEC, however. We’ve seen other situations along these lines in which the mother ship  the entity with the supposed deep pockets  won’t crack open the pocketbook because it doesn’t understand the telecom/communications market. I see this applying in this case too, he said.

But Best Buy could be an advantage as a distribution channel. Analyst Hettick said, Both Best Buy and the combined company could benefit from Best Buy as a channel.

Chatterley said Best Buy and the new CLEC would continue to collaborate. I cant commit to you that all the tests and trials that we are doing will continue, but theres no plan to discontinue those things based on this merger, he said. Best Buy is trialing retail sales of the Speakeasy service in certain East Coast stores.

In addition, he said Speakeasy has a channel relationship with the Best Buy for Business outside sales team on a national basis. These sales reps get leads from small businesses from the stores that they pursue face-to-face program.

Foster added that the merged company would be sticking with its indirect sales strategy, targeting 30-40 percent of its revenue from sales agents and VARs.

Analysts also said the deal makes sense for the three companies on many levels, not the least of which is scale. At more than $500 million  $310 from Covad, $150 from MegaPath and the rest from Speakeasy the merged entity is on its way toward its goal of exceeding $1 billion, Foster said. There it will join CLECs, such as PAETEC, XO Communications Inc. and Level 3 Communications Inc.

Hettick said size is increasingly important for competitive services providers serving the small and medium businesses. Any CLEC small or large is hard-pressed in the small business market because the ILECs have focused on the small businesses and invested a lot, said Hettick. Looming on the horizon are the cable companies with their own networks in place so its a tough market for CLECs.

That said, Hettick said there is a lot more opportunity for niche players in less competitive geographies or underserved vertical markets.

Speakeasy serves more than 30,000 small business customers nationwide through a combination of direct sales and a national network of more than 8,000 IT consultant partners. MegaPath serves more than 19,000 companies with its managed IP communications services, which include broadband connectivity, VPNs, VoIP and security services.

Foster said together these retail-focused companies will be targeting the range of customers from single-location SMBs to midmarket multilocation companies to distributed enterprises.

They are all going after the SMB and midtier markets, said Hettick, noting they have the opportunity to take the best practices and best channel approaches of each.

From an operational viewpoint, the transactions synergies are more obvious. The combination makes sense since Speakeasy was already using Covad for some of their last mile connections, said analyst Jaeger.
In fact, Speakeasy and MegaPath are Covads No. 1 and No. 2 customers in any given month, MegaPaths Foster said, noting this should make integrating the operations easier.

The companies assertion that the combination would create the first managed services local exchange carrier, or MSLEC, drew jeers and cheers from analysts.

NPRGs Clausen said managed services is increasingly a “must-have” in service providers service portfolio for SMBs.

Atlantic-ACMs Reed Smith said it was an interesting approach, but I dont think its a saleable category, in part because similar managed services have been provided to enterprises by large systems integrators for some time.

Foster defended the label, saying the company will push the managed services value proposition because thats what customers are saying is the companys strength.

The new terminology generally is seen by analysts as a lot of marketing spin, and that neither it nor the deal itself will have much impact on the competitive landscape. These are three tiny CLECs, said Jaegers, putting things into perspective.

Clausen agreed: None of these three can be considered dominant and the activity won’t have any special impact on the landscape  either generally or with respect to the competitive service providers.