Q&A: What Birch-Cbeyond Means for Telecom Sector, Indirect Channel

**Editor’s Note: Please click here for Channel Partners’ complete coverage of Birch’s pending acquisition of Cbeyond.**

Two analysts who have tracked the telecom and CLEC industries for more than 15 years each hold different takes on what the Birch Communications acquisition of Cbeyond means for the sector in general and the channel in specific.

Channel Partners asked Craig Clausen, executive vice president and principal analyst of New Paradigm Resources Group (NPRG), and Brian Washburn, service director at Current Analysis, for their insights into the $323 million, all-cash deal, announced on Monday.

Here’s what they had to say:

Channel Partners: What do you think of the Birch-Cbeyond deal, in general?

Clausen: This is a good deal for both companies. The valuation is fair to both sides – providing Cbeyond with the appropriate size premium (i.e. no tremendous multiples) while providing Birch with a value it can absorb without becoming exposed. The relative sizes of the two companies doesn’t affect this deal: Birch is now in a position (after some 20 or so other acquisitions) to effectively integrate a larger carrier and Cbeyond isn’t so large that such an integration becomes an albatross for Birch.

Perhaps most importantly, though, this acquisition again reflects the importance of scale in telecommunications. While both companies have a nationwide footprint, the density of this footprint is less than even. This acquisition evens out that footprint, not only in terms of geographic reach, but also in terms of network infrastructure and services offered.

Washburn: In general, I think it’s an okay fit. Birch mainly focuses on the lower end of SMBs and it has been acquiring a long list of these types of providers (most of them much smaller) to shore up a customer base.

As Birch is privately held, we’ve had little visibility into the company’s overall performance. I’m somewhat surprised that Birch got commitments for $323 million cash for this acquisition so easily. But we were expecting someone to bid for Cbeyond even before the company itself stated it was evaluating strategic alternatives, just based on the low stock price for a service provider with a series of interesting developed products, carrying virtually no debt. Yes, the EBITDA ratio for the acquisition is out of whack, but Birch could make the Cbeyond acquisition be transformative to its business.

Channel Partners: What impact do you think the Birch-Cbeyond deal will have on the telecom sector as a whole?

Clausen: This deal in particular will get the wheels turning at other service providers in terms of what they need to do to remain viable long-term players in an industry in which there isn’t a clear winning direction. Telecom is now directly impacted by what happens in other tech sectors. (Think Google, for instance). And providers with their roots in telecom don’t, for the most part, truly understand the new world order. As such, they’re grappling with what their future will look like and feel a need to do something. Merging with another company, at times, helps everyone feel like they’ve moved forward. Whether or not that’s true is another story.

Washburn: Most of the large CLECs are taking the focus off the lower end of the SMB spectrum, looking at bigger, multisite mid-market customers and above. They’re drawing down the lower end because broadband services that use cable HFC or fiber in the loop, and overall competition for these foundational services, have dropped revenues and margins to points where it’s very hard to compete.

As Birch is privately held we don’t see the numbers; my suspicion is that when Birch acquires smaller service providers serving small businesses, it standardizes products and uses economies of scale to manage these acquired customers for margin (rather than pursuing growth). Cbeyond can hand Birch a well-expanded portfolio, but I don’t see Birch becoming a major increased competitive threat.

Channel Partners: What impact do you think the deal will have on the indirect channel?

Clausen: Both companies have paid attention to the indirect channel and have taken care to groom it (Cbeyond probably better than Birch). The new combined entity’s channel program should emerge stronger. Additionally, the breadth and depth of opportunities available to the channel will be greater under the new Birch. These reps will not only have an improved portfolio to draw from across an improved nationwide footprint, but they can also expect to see increased spending on new technologies and advanced services by the new company.

Washburn: Cbeyond was working to transition from direct sales to more of a channel partner strategy. I’d suspect that Birch can really accelerate that push.

Channel Partners: What’s key about the sale of Cbeyond to Birch that perhaps is not being talked about?

Washburn: There are lots of modern Cbeyond products that Birch could really benefit by slotting into its national portfolio, sold by Birch’s direct sales and channel. I’m thinking Cbeyond’s data center/cloud services; network-hosted VoIP; and design/implementation and service migration services sized to appeal to smaller businesses. Cbeyond will also host a list of business software apps, plus Microsoft apps (SQL Server, Exchange). And Cbeyond also is a wireless reseller that offers the Apple iPhone and some leading Android smartphones and tablets through a national resale agreement (this last one isn’t all that profitable, but is a nice value-add for SMBs that want all their services under one provider).

Channel Partners: Anything else readers should know?

Washburn: Cbeyond had been using Ethernet over copper, fiber access, and some of the more advanced services mentioned above to drive more into the mid-market segment. Cbeyond gets Birch started with EoC colocation and agreements, and metro fiber IRUs in some key markets.

More interesting in terms of what happened to make Cbeyond vulnerable to a sale: Many major competitive providers realized over the past several years that they needed to transform that business to maintain their margins. EarthLink Business is an example of such a provider forcing an extreme makeover, using strategic acquisitions to jumpstart the company’s transformative change. Cbeyond tried to build the business organically: it ended up behind the curve from where it wanted to be, in its transformation into a new type of provider. But the product work is already done, so Birch is in a decent position now to take advantage of Cbeyond’s portfolio of advanced products.