The erectile tissue that underpins the US technology sector is once again at its most priapic. What is it with these flagrant displays of corporate machismo?

In case you missed it, Time Warner Telecom (TWT) last week agreed to pay more than US$500mn for Xspedius Communications, a fibre-based metro CLEC which targets SMEs in the southern United States. According to TWT, it “provides a comprehensive suite of high quality services, including metro Ethernet, local and long distance voice, data and dedicated Internet access services, in 43 markets across 18 states and the District of Columbia.”

In case you're worried, note that Time Warner Telecom paid with US$212.5mn in cash and $319mn in shares. 'Clang, clang, clang go the alarm bells', as Judy Garland once might have sung. Now you can be very worried: the use of shares as M&A currency was one of the factors that directly led to the tech sector's implosion at the beginning of the decade.

In the genes
A glance at the history of Xspedius suggests that it is no stranger to growth through acquisition. Highlights to date include the August 2002 purchase of e.spire Communications and the January 2003 purchase of the Texas operations of Mpower Communications. In August last year, it added ICG Communications to the acquisition list.

There are a number of ways at looking at the strategy for growth. The VCs and PEIs behind Xspedius were obviously bottom-feeding with the earliest acquisitions, which took place with the US CLEC market at its lowest ebb, having been left horribly exposed in a financial sense when technology boom turned to technology bust. That suggests good business acumen and a certain bravery of vision that does not always come with this particular territory.

On the other hand, Xspedius looks from afar like a company whose strategy has revolved first and foremost around securing a big ticket sale. There's nothing wrong with that: this is capitalism, after all. And its US capitalism, to boot: where even malnourished orphans from the wrong side of the tracks can harbour ambitions of growing up to one day become President or, better still, the next Bill Gates.

The downside to this corporate strategy in too many cases is that the long-term endgame becomes more important than the day-to-day running of the business itself. The more green-eyed the management becomes, the less attention paid to widely- accepted principles (yes, even in US-style capitalism!) like 'innovation' or 'customer satisfaction'. Everyone's too busy checking the value of their options to worry about such trivia.

It's a sad but true fact of commercial life but it's a free country, too. So long as customers are free to vote with their feet (something often denied them in the new-look quasi-monopoly environment that is the norm in Europe, for instance), it's a cruel but ultimately fair state of affairs.

Red in tooth and balance sheet?
Where the disconnect tends to appear, however, is when the long-awaited sale itself approaches. A sniff of interest from big buyers inevitably make the big ticket price even bigger. Green-eyed managers find themselves within touching distance of their own personal 'holy grail'. Goodness knows how the affects their behaviour as the negotiations begin.

The situation is compounded when such willing sellers are across the table from such willing would-be buyers. Mutual admiration and an almost demented eagerness to please and impress won't always make for good business.

Which takes us back to the underlying corporate machismo which drives so many deals in this sector. Serial acquisitors like Cisco and Oracle have basically admitted that it is the only way for them to achieve substantial year-on-year growth. One often suspects that Cisco, in particular, thinks about little else (for evidence of this, click here).

It's hard to put TWT's purchase of Xspedius in this category, however –although there are some tell-tale signals. Jim Lynch, representative of majority Xspedius owner, Thermo Capital Partners, and Chairman of Xspedius Communications, said: “Time Warner Telecom is clearly an innovative market leader. I am impressed with their ability to serve the enterprise customer with a broad range of services, their market success, and the scalability of their business model. This combination creates significant synergies and will enhance Time Warner Telecom’s overall growth rate.”

“This acquisition significantly broadens the already extensive nature of our local assets and national capabilities,” said Larissa Herda, Chairman, CEO and President of Time Warner Telecom. “The marketplace continues to validate our long-held view of the value of last mile connectivity to enterprise customers.”

Like father like son?
TimeWarner, which owns just under 50% of TWT, is currently worth about US$75bn; included in that figure is 100% of the stock in AOL for which it paid US$124bn in 2001; not the best piece of business ever recorded, or so one might infer. In August 2005, TimeWarner paid a further US$3bn to shareholders for irregularities surrounding the AOL takeover; not the best nor the cheapest piece of business ever recorded, therefore.

For its part, TWT is currently worth less than US$1.4bn, which makes its acquisition of Xspedius, which otherwise wouldn't register on the telecom M&A Richter scale, look a tad more seismic. It probably also explains the reliance on its own shares to fund the deal.

The deal certainly raised some eyebrows. "We see some strategic benefits from the acquisition," said Standard & Poor's credit analyst Catherine Cosentino. "However, given the small size of Xspedius relative to Time Warner Telecom, the acquisition's operational benefits do not materially assuage our fundamental concerns about the company's longer term business prospects."

Thin end, big wedge
It is quite possible that there is nothing intrinsically wrong with the thinking behind TWT's acquisition of Xspedius. Yet some of its nuances are troubling. It's that sense of acquisition for the sake of it, the idea that doing something is always preferable to doing nothing in a flat trading climate, whatever the cost. It's the reminder that companies can be traded like commodities with little regard for customers or employees (and in certain cases, shareholders).

And above all, maybe it's down to the TimeWarner connection. The telecom sector is particularly susceptible to reflex reactions to peer-group mergers. These more often than not set off an inflationary spiral and, when the luck runs out, more gloom all around.

It's the old chestnut about learning the lessons of history. And in the case of technology M&A, the first such lesson is that most companies prefer not to visit that subject at all.
Jim Chalmers