Transcript www.gta.org

Emerging Strategic Challenges for Rural Carriers:
Financial Outlook and Directions
Georgia
Telecommunications
Association
Francis X. Gallagher
June 19, 2012
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Overview
 Purpose
▫ Financial perspectives on current ILEC challenges and opportunities
▫ Potential directions
 Presentation
▫ Telecom industry operating trends
▫ Financial import of the regulatory sea change
▫ Opportunities for Georgia ILECs
 Philosophical view
▫ Industry has been remarkable for more than a century
▫ Fundamental changes—technology, competition, regulation
▫ Next epoch will emerge from insightful, correct strategic choices
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Detailed Quarterly Wireline Trends
Revenue Growth
ALSK
CTL
CNSL
FTR
TDS
WIN
Average
Median
1Q10
-4.3%
-6.7%
-3.4%
-3.4%
-2.9%
-2.8%
-3.9%
-3.4%
2Q10
-1.6%
-7.0%
-6.2%
-3.0%
-0.8%
-3.0%
-3.6%
-3.0%
Access Line Growth
3Q10
-1.5%
-6.8%
-5.9%
-7.3%
0.7%
-1.5%
-3.7%
-3.7%
4Q10
2.1%
-6.4%
-7.0%
-6.6%
0.3%
-2.2%
-3.3%
-4.3%
1Q11
5.0%
-5.8%
-2.9%
-7.5%
3.0%
-1.8%
-1.7%
-2.3%
2Q11
0.5%
0.7%
-3.3%
-7.8%
3.8%
0.1%
-1.0%
0.3%
3Q11
0.6%
-4.6%
-3.2%
-8.0%
4.7%
-1.4%
-2.0%
-2.3%
4Q11
3.2%
-3.2%
-0.1%
-5.6%
4.0%
0.7%
-0.2%
0.3%
EBITDA Margin
ALSK
CTL
CNSL
FTR
TDS
WIN
Average
Median




1Q10
36.1%
42.8%
47.9%
47.9%
24.3%
49.7%
41.4%
45.3%
2Q10
37.3%
45.2%
48.0%
45.7%
22.5%
49.5%
41.4%
45.4%
ALSK
CTL
CNSL
FTR
TDS
WIN
Average
Median
1Q10
-6.1%
-8.4%
-5.8%
-6.0%
-4.7%
-3.9%
-5.8%
-6.0%
2Q10
-5.7%
-8.0%
-4.8%
-6.3%
-4.2%
-3.7%
-5.4%
-5.7%
3Q10
-5.1%
-7.8%
-4.3%
-9.3%
-4.2%
-3.7%
-5.7%
-5.1%
4Q10
-4.4%
-7.6%
-4.1%
-9.0%
-5.3%
-3.6%
-5.7%
-5.3%
1Q11
-3.9%
-7.5%
-4.0%
-9.0%
-5.5%
-3.6%
-5.6%
-5.5%
2Q11
-4.6%
-7.4%
-4.1%
-8.6%
-5.5%
-3.6%
-5.6%
-5.5%
3Q11
-5.2%
-7.1%
-3.9%
-8.5%
-5.2%
-3.9%
-5.6%
-5.2%
4Q11
-5.9%
-6.6%
-3.9%
-8.3%
-5.1%
-4.0%
-5.6%
-5.9%
1Q11
-1.5%
6.1%
5.4%
-0.2%
4.2%
5.7%
3.3%
4.8%
2Q11
-1.0%
4.3%
5.0%
2.5%
3.4%
4.8%
3.2%
3.9%
3Q11
-1.5%
4.0%
4.4%
2.5%
3.8%
4.3%
2.9%
3.9%
4Q11
-3.0%
4.5%
4.3%
2.6%
2.5%
4.2%
2.5%
3.4%
Broadband Sub Growth
3Q10
38.7%
44.8%
48.9%
47.9%
21.8%
49.5%
41.9%
46.3%
4Q10
36.0%
44.9%
48.9%
45.8%
16.8%
39.1%
38.6%
42.0%
1Q11
36.6%
45.7%
48.8%
46.5%
22.3%
50.1%
41.7%
46.1%
2Q11
36.1%
41.1%
49.5%
47.9%
25.3%
49.8%
41.6%
44.5%
3Q11
36.3%
43.2%
50.0%
47.2%
23.2%
49.6%
41.6%
45.2%
4Q11
34.7%
39.7%
51.6%
48.0%
16.4%
39.0%
38.2%
39.3%
ALSK
CTL
CNSL
FTR
TDS
WIN
Average
Median
1Q10
-1.3%
8.9%
8.0%
7.3%
11.2%
9.9%
7.4%
8.5%
2Q10
-1.9%
8.9%
8.1%
5.5%
9.5%
9.2%
6.5%
8.5%
3Q10
-1.9%
8.0%
7.3%
2.2%
8.2%
8.0%
5.3%
7.7%
4Q10
-2.0%
7.1%
6.3%
1.4%
6.4%
6.5%
4.3%
6.3%
Access line losses at rates that show no material sign of improvement
Revenues stable year-over-year
Margins weakening, but negative seasonal effect in the fourth quarter
Broadband sub growth is stable; except results reported at ALSK
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Broadband Trends
HSD Subscriber Growth
HSD Market Share
Source: UBS Investment Research, company data
 Broadband growth has weakened precipitously since mid-2011
▫
▫
▫

DSL growth stopped and then began to contract materially in 2Q11
ILEC growth has slowed v. cable growth; cable offerings more robust
Market share shift toward cable since mid-2010; has cable “won” the
wireline battle in non-FTTH markets
ILEC / total broadband growth driven by fiber-based adds
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Revenue Generating Unit Trends
Year-over-Year Change in Revenue Generating Units


Cable Index
(1)
Source: Company filings and press releases
(1) Cable index is comprised of CVC, CHTR, CMCSA, MCCC, and TWC.
(2) RLEC index is comprised of ALSK, CTL, CNSL, FTR, TDS, and WIN.
Cable losing basic video subs, replacing with
High Speed Data and voice
RLEC RGUs contracting since 3Q08, as
broadband adds can’t fully offset access line
losses
RLEC Index
(2)
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Revenue and EBITDA Trends
Year-over-Year Change in Revenue and EBITDA


Cable Index
(1)
:
Revenue
EBITDA
Source: Company filings and press releases
(1) Cable index is comprised of CVC, CHTR, CMCSA, MCCC, and TWC.
(2) RLEC index is comprised of ALSK, CTL, CNSL, FTR, TDS, and WIN.
Trends generally mirror RGUs
RLEC trends improving since mid-2010,
largely due to diversification efforts
(broadband, business, data centers,
etc.), and management of costs
RLEC Index
(2) :
Revenue
EBITDA
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Wireless Overview
 VZ/AT&T generate ~90% of U.S. wireless FCF
 Question about service revenues (w/o handset revs) and
profitability quarterly through 4Q11
▫
▫
▫
AT&T 4Q11 service revs slipped to 4% growth
VZ service rev growth more stable;
~6% in 4Q11
ATT 4Q11 EBITDA growth -12.7%; for
VZW -5.3%
Total Service Revenue Growth
 ARPU growth pressured, suggesting
weakness in the future in spite of data
volume growth
▫
▫
▫
▫
AT&T ARPU 4Q11 growth contracted (-4.0%)
VZW ARPU growth in 4Q11 was 0.0%
Industry-wide ARPU growth negative since
late 2008
High-margin smartphones v. lower-margin
devices (tablets, dongles, data cards, etc.)
EBITDA Growth
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The Race to 4th Generation Services
Long Term Evolution
WiMAX
Verizon completes LTE network build
2014
Clearwire committed to WiMAX through 2015
Clearwire launches LTE network
Verizon LTE coverage equal to 2010 3G coverage
2013
T-Mobile launches LTE network
Verizon offers service to ~200M POPS
2012
Clearwire offers service to ~130M POPs
U.S. Cellular launches LTE network
AT&T launches LTE network
2011
Verizon launches service to ~110M POPs
MetroPCS launches LTE network
Source: Company websites and press releases
2010
Clearwire offers service to ~120M POPs
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Order Provisions by Carrier Type
Price Cap & ROR
Price Cap Only
ROR Only
Wireless
Universal Service Fund / Connect America Fund (CAF)
•
•
•
•
Public interest obligations for
voice, broadband in supported
areas (based on speed, latency,
capacity)
Annual budget of $4.5B; up to
$1.8B price cap, $2B ROR
Rate floors ($10 beg. 7/12 and
$14 beg. 7/13)
Per line caps on USF; 3-yr. phasein; no more than $250/month
after 7/14
•
•
•
•
•
•
•
Freeze support at 2011 levels
From 2015, 100% used on BB
where no subsidized comp.
Phase I: up to $300 million in
one-time support ($775/line)
Phase II: ongoing support of ≤
$1.8 mil./yr. for 5 yrs.; optional
4/1 up Mbps to all supported
locations statewide by end yr. 5
Forward-looking cost model
Auction if LEC declines
•
6-year transition to bill-and-keep
(see p. 271)
ARM baseline is 90% of 2011
2011 MOUs reduced 10%
annually
Limitations on charges passed
through to customers
If use CAF (with obligs.) to offset
ICC reduction, phase-out over 3
years starting in 2017
Bill-and-keep for LEC-CMRS nonaccess traffic begins in July 2012
Caps intrastate originating rates
•
•
•
•
•
By July 2012, 4/1 BB must be
provided upon request by LECs
drawing ICLS, HCLS, or CAF
Limits on reimbursable capex
and opex beg. in July 2012
SNA eliminated; LSS frozen 1/126/12, eliminated 7/12
Phase out support over 3 yrs.
where unsubsidized competitor
Evaluate 11.25% ROR
•
No cap on originating intrastate
access
9-year transition to bill-and-keep
termin. interstate (p. 271)
Inter- and intrastate transport
capped at current interstate
ARM based on 2011 interstate,
intrastate, net recip. comp.
5%/yr. reduction to baseline
ICC-replacement CAF support
phases out as eligible recovery
decreases over time
Bill-and-keep for LEC-CMRS nonaccess traffic begins in July 2012
•
•
•
•
•
•
Phase I: $300 mil. one-time for
currently unserved areas
Reverse auction to award
support; no identical support
3G (200/50 kbps) in 2 yrs.; 4G
(768/200 kbps) in 3 yrs.; 75% of
road miles in unserved blocks
Eligible provided no publicly
disclosed plan before 1/2013
Phase II: $500 mil./yr. ongoing
5-yr. transition of CETC funds
Intercarrier compensation
•
•
•
•
•
•
•
•
Transition interstate terminating
to bill-and-keep
Interstate elements capped
Terminating intrastate rates
capped for all carriers
Caps price cap intrastate
originating rates (not ROR)
Recovery mechanism (ARM)
transitional, not revenue neutral
Recovery through ARC + CAF
No ARC above $30 res. rate
ceiling; no multi-line bus. ARC if
SLC+ARC above $12.20/line
If recovery > ARC rev., then CAF
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
6-yr. transition to bill-and-keep
for terminating interstate access
Bill-and-keep for LEC-CMRS nonaccess traffic begins in July 2012
Rules for transport within and
outside rural ROR LEC’s service
area (to interconnection point or
meet point)
Traffic to/from CMRS provider in
same MTA is subject to recip.
comp., not access
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Rural Financials
2012
L-T effects of
initial reform
Pending
“reforms”
Caps and other limits
reduce rural funding
USF remains capped;
carriers hesitant to
accept restrictive
obligations; CAF not
defined
More reductions:
proposed ROR, safety
net additive, $250 cap
target in 3 steps, comp.
overlay, low rate adj.
Access funding
+
Wireless recip. comp and
initial step-down in
intrastate access revenues
(RM from capped fund)
Estimated $1.215 billion
in rural-related total
access revenues (~60%
terminating)
Orig. access (~$500
mill)
Competitive
pressures
=
Increased rates, ongoing losses in denser, more profitable regions; shift of
operations toward unprofitable regions with lesser internal cross-subsidization
from profitable regions; increasing costs to meet evolving broadband challenges
Net effect
Reductions in cash flows;
operating/investing
contraction in uneconomic
regions
USF
+
Net reduced cash flow
from access and USF,
possibly $1.5 billion
annually
Re-prescription of ROR
reduces cash flows and
raises risk (cost of
capital)
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Approximate Revenue Outlook
 Rural USF/ICC loss
▫ Reductions assume
▫
▫
changes in HCLS, ICLS,
Safety Net Additive, $250
per line per month cap, ICC
reductions, and changes to
ROR
The rural industry could
have reductions of nearly
$1 billion in support in 2020
Cumulative reductions
could be $5.2 billion from
2012 to 2020
Source: NECA estimates
June 19, 2012
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Small Company Metrics
7500+ lines
USF
Network access
Total access/USF
EBITDA margin
Interest expense
1,000-3,000 lines
USF
Network access
Total access/USF
EBITDA margin
Interest expense
<1,000 lines
USF
Network access
Total access/USF
EBITDA margin
Interest expense
Company 1
Company 2
Company 3
Company 4
Company 5
Company 6
Average
0.0%
50.7%
50.7%
22.8%
59.5%
82.3%
13.9%
54.6%
68.5%
8.6%
51.9%
60.5%
36.8%
43.5%
80.3%
37.6%
55.5%
93.1%
20.0%
52.6%
72.6%
25.5%
-0.7%
49.2%
-6.5%
29.4%
-3.9%
34.0%
-1.6%
40.1%
-5.3%
49.1%
-7.2%
37.9%
-4.2%
Company 1
Company 2
Company 3
Company 4
Company 5
0.0%
57.5%
57.5%
27.2%
39.7%
66.9%
13.4%
56.8%
70.2%
24.3%
70.3%
94.6%
31.9%
35.4%
67.3%
19.4%
52.0%
71.3%
26.2%
-6.2%
30.0%
-4.5%
30.5%
-3.8%
48.8%
-9.2%
45.6%
-0.3%
36.2%
-4.8%
Company 1
Company 2
Company 3
Company 4
18.2%
65.5%
83.6%
3.0%
72.6%
75.6%
19.3%
68.5%
87.8%
19.1%
55.8%
74.9%
14.9%
65.6%
80.5%
36.4%
-3.2%
30.7%
0.0%
18.0%
-1.3%
27.2%
-6.1%
28.1%
-2.6%
Source: Confidential company information; Balhoff & Williams, LLC
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Illustrative EBITDA Outlook



Simplifying assumptions
▫ EBITDA margin = 36%
▫ USF + access = 75% of revenues
▫ Cost benefits of reforms = 0%
USF reform and effect of rural growth factor reduces
EBITDA margin in this illustrative analysis slips from
36% to 13% by 2020
Interest expense (typically 4%-6%
of today’s revenues) would eliminate
more than half of the residual
cash flow by 2020, leaving ILEC
with little cash for capex
or principal repayment
Source: Estimates by Balhoff & Williams, LLC
June 19, 2012
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Focus on Operating Cash Flow
Operating CF margin
Sensitivity of Operating CF to Percentage of Revenues Lost


0.0%
15%
20%
25%
30%
35%
40%
45%
50%
5%
33%
25%
20%
17%
14%
13%
11%
10%
Percentage of revenues lost
10%
15%
20%
67%
100%
133%
50%
75%
100%
40%
60%
80%
33%
50%
67%
29%
43%
57%
25%
38%
50%
22%
33%
44%
20%
30%
40%
25%
167%
125%
100%
83%
71%
63%
56%
50%
30%
200%
150%
120%
100%
86%
75%
67%
60%
Minimal revenue impact can be substantial in terms of cash flow
Contracting cash flows put pressure on interest payments, appropriate returns
to equity holders, principal repayment, capex and new business development
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Potential/Probable Outcomes
Operating


Reduced or eliminated near-term capital investment (almost certainly no increase)
Proximate reductions in personnel and other operating costs
Financial



Increased cost of capital
Insufficient recovery, skepticism about or avoidance of sector by debt (primary concern for
RUS companies) and equity investors
Companies will evaluate consolidation, made more complex by financial risks and concern
over potential bankruptcies
Customer service


Growing urban-rural divide in terms of investment and telecommunications services
Rates will rise in rural regions for services less than comparable to those in urban areas
Policy



COLR becomes more problematic if uneconomic mandates are underfunded or unfunded
Services will no longer be “comparable” in urban and rural regions
Potential exists that private-public partnership fails; no one may bid at reverse auctions
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Telecommunications Industry Dynamics
Challenges
Opportunities

Increased organic growth

Regulatory reforms

Broadband

Continued cable competition

Video


CLEC
Continued wireless voice
substitution

Wholesale fiber transport

Increasing costs of capital

Decreasing credit availability

Wireless data substitution

Hosted and managed services

Acquisitions of assets/
operations: CLEC, Fiber,
Hosted/managed services, ILEC
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June 19, 2012
ILEC Strategic Approaches
 Strategic clarity is critical
▫
▫
Fundamental industry changes lead to value creation or destruction
Focus on opportunities and challenges
 In view of the prevailing industry dynamics, ILECs have tended to
pursue four broad strategic approaches (or some combination thereof)
▫
▫
▫
▫
Increase ILEC scope/scale through M&A (rationalizing cost structure)
Diversification




Reducing regulatory exposure
Geographic diversification
Expansion of network assets and business lines – CLEC and fiber
Entry into business-centric internet / data services
Hybrid – grow ILEC scope and scale while seeking business diversification
In-region organic opportunities
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ILEC M&A Valuations
Purchase Price as a Multiple of LTM EBITDA
Source: Company press releases and filings
(1) Windstream / Iowa transaction value includes the value of Iowa’s net operating loss carry-forwards (multiple would have been lower without NOLs).
June 19, 2012
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ILEC Enterprise Valuation Trends
Enterprise Value as a Multiple of LTM EBITDA
RBOCs
Source: Company filings and press releases
Integrated ILECs
High Yielding ILECs
Pure Play ILECs
June 19, 2012
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June 19, 2012
The Power of Synergies
 Creating synergies in ILEC transactions
▫
▫
Approximately 11% of revenues
Approximately 27% of earnings before
interest, taxes, depreciation, and
amortization (operating cash flow or
EBITDA)
Potential Synergies
Public Company Expenses
Executive Expenses
 Enterprise value to EBITDA
▫
▫
Pre-synergy valuations about 6.9x
Post-synergy valuations about 5.5x
 Valuations declining more recently
 Regulatory pressures will depress
valuations
Back Office Support
Information Technology and
Systems
Transport Synergies
Revenue Synergies
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EATEL Acquires Vision Communications
 Announced: September 20, 2011
 Target: Vision Communications (“Vision”) (a





portfolio company of BV Investment Partners)
(“BV”)
Buyer: EATELCORP, LLC (“EATEL”)
Price: Not disclosed
Assets: Founded in 1945, Vision provides a
broad array of advanced telecommunications
services including digital cable TV, high-speed
Internet access, local and long distance voice,
and commercial data services. Headquartered in
Larose, Louisiana, Vision serves residential and
commercial customers throughout central and
southern Lafourche and southern Jefferson
Parishes. Vision served approximately 9,850
access lines at announcement.
Closed: January 5, 2012
Comments: The acquisition enables EATEL to
expand and diversify its service territory
throughout southeastern Louisiana from
Livingston Parish to southern Jefferson Parish.
Charlesmead Advisors, LLC served as exclusive
financial advisor to EATEL in this transaction.
Source: EATEL press release and JSI
Service Territory Map
June 19, 2012
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Internet Infrastructure—Smaller ILEC Acquisitions
•ILEC
•Data Center
Operation
•Description
> Two data centers / 10,000 total square feet
> First enterprise level data center in South Carolina
> Provides an integrated suite of managed services and
infrastructure solutions for critical business applications
> Colocation, dedicated Internet access, data backup/
recovery, network monitoring, and network security
> Two data centers / over 70,000 gross square feet
> Serves 10,000 business and residential customers
> Colocation, managed services, cloud computing, web and
application hosting, and Internet services and support
> Customers includes 3M, Caribou Coffee, HealthPartners,
and Miracle-Ear
> Three data centers / over 5,000 net square feet / WA state
> Provides colocation, transport, and dedicated Internet
access services via multiple Tier 1 Internet connections
> Also offers managed Internet, hosting, and e-mail services
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June 19, 2012
North State Communications Acquires DataChambers
 Announced: December 15, 2011
 Target: DataChambers, LLC
 Buyer: North State Communications (OTC:





NORSA.PK)
Price: Not disclosed
Assets: DataChambers provides information
technology services, including electronic data
storage, managed information technology
solutions and secure co-location services for
mission-critical infrastructure. Two data
centers and disaster recovery space in its
120,000 square foot facility located in
Winston-Salem, North Carolina.
Valuation Multiples: Not disclosed
Closed: December 28, 2011
Comments: Acquisition enables North State to
accelerate its strategy of diversifying its
business and revenue mix. Transaction will
strengthen North State’s efforts to become
becoming a preferred business
communications and data solutions provider.
Charlesmead Advisors, LLC served as
exclusive financial advisor to North State
Communications in this transaction.
Source: North State Communications press release and DataChambers website
DataChambers Data Center Facility
DataChambers Products and Services

Data center services with remote hands services

Managed services incl. databases, firewalls, VPNs

Advanced monitoring services for servers,
desktops, routers, switches, and applications

Data protection/backup with IBM’s Tivoli Storage
Manager & eChambers Intelligent Data Protection

Virtualization and cloud solutions

Business continuity space w/ redundant networks

Desktop management/support to configure PCs,
install patches, managed security and firewalls

24/7 help desk provides Tier 1 to Tier 3 services
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GTA
Import for Georgia ILECs . . .
 Georgia ILECs
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Significant competition from cable and wireless that will increase
Regulatory support revenues will erode rapidly
State regulatory oversight has limited acquisition activity
 Regulators, however, recognize the changing environment
 Lingering negative perceptions among potential acquirors
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Several major ILECs in state with defined strategies
Many small ILECs in state with less strategic clarity
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Engage soon in a realistic strategic assessment
Focus on value preservation/creation
 A small ILEC will need to . . .
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Operating focus
Scope and scale
Diversification
Reduced reliance on regulation
June 19, 2012
28
GTA
June 19, 2012
Focused Alternatives
 Create/evaluate a ten-year financial model (consistent with reforms)
 Responding to the new public mandate
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Assume the operating model is not the same as historical model
Create a “no-support” model that generates appropriate returns
New obligation—survive to serve customers for the long term
Communicate with customers/regulators about reasonable model
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Evaluate all non-strategic assets with a view to divestiture
Assess whether company is buyer or seller of strategic assets
Focus on efficiencies and optimization of operations
List and evaluate diversification opportunities
Consider all strategic approaches/combinations
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Shareholders
Lenders
 Develop alternatives for improving the operating outlook
 Evaluate/discuss capital resources with all key parties
29
GTA
Representative Transactions
Has Agreed to sell
Spectrum to
Has Acquired
Spectrum from
Advisor to Seller
Advisor to Buyer
Advisor to Buyer
Advisor to Buyer
Pending
February 2012
January 2012
December 2011
Has Acquired
Has Acquired
June 19, 2012