RCN and Neon: A Match Made in Wholesale Heaven?

RCN Corp.s recent acquisition of NEON Communications Group could be an ideal pairing or a flop waiting to happen it all depends on who you talk to.

To RCN, a cableco competing against Verizon Communications Inc. for triple-play subscribers, a merger with retailer/wholesaler NEON provides complementary customers and network assets. Together, RCN and NEON will boast more than 4,000 route miles and more than 1,000 on-net buildings, the companies say.

For analyst group ATLANTIC-ACM, the marriage of the two companies signifies financial health and the right combination of strengths to shore up the others weaknesses. Yet, to Current Analysis Inc. experts, theres not enough background in common to support this union.

Virginia-based RCN announced on June 25 it will buy NEON, formerly Globix Corp., for up to $5.25 per share in a deal totaling approximately $260 million. Both companies boards have approved the acquisition, which should close in the fourth quarter. RCN expects to pay for the acquisition with $250 million of debt financing and $10 million in cash. The purchase price could go down by 10 cents per share if NEON doesnt meet its revenue targets for the second half of 2007. Affiliates of Deutsche Bank have agreed to fund the $250 million.

First, the pros. ATLANTIC-ACMs Judy Reed Smith, founder and CEO, says the lack of competition between RCN and NEON bodes well for the companies. NEON has focused on selling transport to carriers, while RCN has targeted consumers and businesses.

But thats the very problem, say Cindy Whelan and Brian Washburn, analysts for Current Analysis. RCN is paying too much and getting too little, they write. They acknowledge theres some complementary geographic overlap between the two, but not enough to merit the $260 million price tag. The opportunities for synergy between the two businesses seem meager, say Wheland and Washburn, adding that RCN is expecting to see only $10 million in cost savings and new revenue after the merger closes.

Reed Smith notes RCN will need to execute its plan carefully to ensure it gets more market share. She is optimistic, though. The bottom line on this deal is it offers genuine opportunities for synergy in both scale and scope, she says.

To little surprise, RCN and NEON executives share that outlook. Peter Aquino, RCNs president and CEO, says NEONs fiber network in New England and the mid-Atlantic is a huge boon to the company, along with intercity fiber. Add to that RCNs purchase of Con Edison Communications Holding Co. last year and subscribers in Tier 1 and Tier 2 markets have another alternative to incumbents, he says.

The payoff for NEON is that now it will be able to serve Chicago and gains concentration in New York City and Washington, D.C., says Kurt Van Wagenen, president and CEO of NEON.

Overall, RCN is making the most of a unique business model, says Reed Smith. The company started as a cable overlay provider. When it found it couldnt cover the debt it racked up to build the consumer-focused network, it went bankrupt. That gave RCN a new beginning and, this time, RCN included business customers in its strategy.