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For Telecom, a Whole New World

After SBC announced its planned acquisition of AT&T on Jan. 31, the stock gained slightly more than 1% over the next two trading sessions, a reaction that seemed to indicate the Street regards the acquisition as a good idea (see BW Online, 2/1/05, "Pitching SBC-AT&T to Investors"). Not everyone agrees, however. Todd Rosenbluth, a Standard & Poors equity analyst who covers the telecom industry, maintained both stocks at hold ratings after the announcement. The companies hope that they'll benefit from the $16 billion merger by cutting labor costs and info-tech expenses, as well as play off each other's strengths in enterprise- and fiber-based services.

Rosenbluth recently chatted with BusinessWeek Online's June Kim about the merger and why he thinks it will cause turmoil in the telecom industry. Edited excerpts of their conversation follow:

Q: Why do you have hold recommendations on both SBC (SBC) and AT&T (T)?

A: We think the stocks are trading in line with where they should. There's not as much upside for people who want to buy either SBC or AT&T stock. For people who own the stocks, their dividend yields will allow shareholders to receive positive total return. If you already own shares, then we recommend holding onto them because of the dividend yield.

For people who don't, we're not recommending they buy. We had a sell recommendation on SBC from January, 2002. We upgraded the shares to hold on Jan. 27, when the stock almost reached our target price due to its 5%-plus dividend yield.

We have concerns [that] this deal, presuming it gets closed, will have long-term benefits for SBC but is not expected to be positive to SBC's earnings...until 2008. In our view, SBC will face a lot of challenges between now and then.

Q: What are some of those challenges?

A: The roll-out of new fiber-based services, high fixed costs, an effort to retain wireline customers, as well as forces they can't control.

Q: Do any of these challenges have anything to do with the integration of AT&T?

A: We think that they face challenges even before the needed integration of AT&T...a significant acquisition that will require workforce reductions, technology-streamlining efforts, and back-office integrations that are not easy to accomplish while other forces are affecting the company.

In addition, between now and when the deal closes...and 2008 when the deal is expected to benefit earnings, SBC faces increasing competition from cable and wireless companies. In our view a number of regulatory uncertainties should impact SBC's operations.

Q: What about the players in the rest of the telcom industry?

A: We think they're going to see how best to compete with this new company and are going to continue to try to market their own services in an attractive, often discounted manner to offset some competitive pressure. They will also be affected by companies outside the telcom industry, mostly cable companies that are offering their own bundles of video and Internet. Some of them already have a telephone component, while others are rolling that out throughout 2006.

It's going to be an interesting time in the telecom space. We think there's turmoil ahead as a result of the SBC acquiring AT&T.

Q: Are the regulatory approvals going to be a problem?

A: We think [the acquisition] will be completed by middle of 2006. However, there are close to 26 state regulatory bodies that are going to weigh in, as well as the Federal Communications Commission, which is undergoing change in leadership, as Michael Powell is set to resign in March. A lot of things have to happen.

Q: So what are the benefits of this merger?

A: There are two main attractive components of AT&T: its enterprise customer base and its nationwide network capabilities. SBC [is gaining] access and entry to AT&T's enterprise-business customer base, which we believe is more stable than SBC's consumer market. We think that SBC has achieved some success in recent fiscal periods, but that AT&T is the market leader in a highly profitable segment of the telecom space.

We believe that AT&T's nationwide network and its breadth and depth of services are appealing and can help SBC roll out new fiber-based technologies. Also, SBC's geographic profile will be increased. SBC operates mostly in the Midwest, in some Southern parts of U.S., and parts of the Western U.S. For consumers and businesses located in Verizon (VZ) territory in the Northeast or the Southeast, where BellSouth (BLS) is the name carrier, SBC's presence is much more limited.

Q: You also downgraded Verizon to buy from strong buy [on Jan. 31]? Why?

A: We still think Verizon is a stronger performer than its peers, including SBC, but we think there is a possibility that Verizon will explore a strategic [partnership] with a telecom company that has a nationwide network and a presence in the enterprise market. Verizon has a regional network primarily in the Northeast and has focused on the consumer market.

Q: Do you see more consolidation in the future?

A: We think there's added risk of consolidation, and that's one of the reasons we reduced our recommendation on Verizon from a strong buy to buy. We think that's a possibility Verizon will explore.

In addition, we think the SBC-AT&T deal will put added competitive pressure on Verizon as, in our view, SBC is likely to target consumers in the Northeast with its bundle of services. These bundles include voice, high-speed Internet, and soon-to-be-rolled-out video services.

Q: What's your outlook for the telecom industry?

A: We have a lowered outlook because of the growing competition. We've seen a blurring of competitive lines between long-distance service and local service for the past few years. SBC and AT&T, for instance, have been competing in each other's traditional backyards....but this is the first time a predominantly local, consumer-oriented, wireline carrier and a predominantly long-distance, business-oriented wireline carrier have merged.

We think that the planned deal of SBC and AT&T causes an imbalance in the industry because, in our view, it will likely lead to SBC-AT&T competing in other Bell local-carrier markets like the Northeast and Mountain West states, where Qwest Communications (Q) operates, and the Southeast, which is where BellSouth operates.

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