PAETEC's Chesonis comments on Cavalier acquisition at COMPTEL keynote

Arunas Chesonis, Chairman and CEO of PAETEC (Nasdaq: PAET), walked onto the stage Monday at COMPTEL PLUS Fall 2010 to face an audience abuzz with the news--only a few minutes old--that PAETEC would acquire Cavalier Telephone for $460 million in cash.

The standing room only crowd stayed through the initial keynote for the post-speech Q&A to hear Chesonis' take on the deal. Below are answers to questions directly addressing the deal.

Q. How does Cavalier fit the 10 year plan?
Chesonis: We've decided as a board and as a management team that we need to have a much higher percentage of our customers connected on our own physical fiber to their location or at least a majority of the distance there on metro fiber. To be able to not just service them properly, provisioned by SLAs, but also to be able to negotiate better deals with other people that couldn't provide connectivity in some place that you can't afford to go. So you need sort of a balance of both. We decided we need to build that out. But you can't build it out fast enough organically. You also need to acquire other people's assets. And if you continue managing people who spent a lot of money in the past, but they went and got into sort of tough financial times, you can pick them up for really pennies on the dollar. That's sort of the first part, most important part.

The second part is, you just need to build more scale as a company. One of our biggest issues when we're trying to get a new partner with our customers, is people still think that we're not financially viable compared to the cable companies or the different ILECS, and we just need to get up this larger entity, a big organization like they are internally. The Fortune 1000 status helped us a lot on the marketing side, but once you get in the Fortune 500 with 4 or 5 billion, positive drivers for your cash flow, got more leverage, you've got no issues financially, then people feel much more secure giving you a piece of their business... because it's their jobs, it's their families depending on them not losing their jobs... Again that perception that we're not viable that some people have, that's really important. ...I think it helps us focus.

Q. You started out with just vertical market you move forward, how important is fiber to the success of your organization?
Chesonis: I think it's very important. Again, we could have picked a lot of different organizations to try to acquire right now, and we decided that it was more important to drive more of the fiber business than maybe acquire some of the data center opportunities or go overseas right away. I actually think there's a whole renaissance happening in the fiber business where people are looking at the low latency between destinations for certain reasons, a popular one is the Chicago to New York financial institutions, right? But it just doesn't stop there. I mean, you talk about all the people that are connecting to data centers, that are getting out of their own internal data center business, when they replicate their information, they want to have low latency on not just the primary route but the diverse route. So if your diverse route is a fiber company, let's say you're a great sun wire facility buildout or something and you're in Northern Virginia. Your primary route for replication is pretty good. But sometimes, depending on the carrier you buy from, that backup route may take you all the way back down through Atlanta, back through Chicago, down through the Midwest. You can't have that sort of mismatch of latency, it's not as effective. So the network that Cavalier has, the network that other people have, it's very important to look at something like that as well as the unique routes. So many people sold IMUs and dark strands to other people that there's really, a lot of carriers' footprint there's not a lot of routes that are just unique to them. What was great about Cavalier is they do have some unique routes. ... I think there's a whole new program there. People used to think middle mile and transport interstate wasn't important, and it was just about the connection from the metro to the enterprise building, and I think people are rethinking that. I think they're saying, a path between last mile, middle mile, and transport, you've gotta have all three.

Q. How do you view mobility as part of your strategy?
Chesonis: We've been struggling with that for as long as 10-12 years, because we actually did a lot of university business in the early days, and we--that was when you needed authorization code for LTE and voicemail, and that's obviously changed for universities. But we never could get a decent wholesale gross margin from the different wireless providers to make it worth our while because our enterprise customers really weren't leaving us because we didn't have a bundled wireless program where we could save 50 percent. I think you kind of know where the industry is at, some of the winners and some of the people that have still got things to do, and I think some of the folks that are trying to break in to higher market share, I think they're being much more willing to be more aggressive on gross margins and spreads, but they've still got inventory issues, still got all the other stuff going on. I just think it's imminent whether it's this fall, next fall, sometime we have to start bundling wireless into the package, and that'll be something to look for for the future.

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