By Steve Rosenbush If Qwest Communications (Q) and MCI (MCIP) merge, this would unite two of the most troubled survivors of the telecom bust. Qwest has offered to acquire MCI in a deal worth $6.3 billion, people close to the talks said Feb. 3.
Both companies soared during the tech boom of the late '90s but were brought low by financial trouble and scandal. Now they're looking for a deal that will help them move forward in the quickly consolidating telecom market.
DEBT SOLUTION. It's a deal of desperation, driven by the fact that neither concern has much of a future on its own, analysts say. But even a combined entity would emerge as a relatively small and weak player as other telcos are busy joining up as well. The combination of SBC (SBC) and AT&T (T), a deal announced on Jan. 31, would be larger and more powerful in every way.
That's why MCI managers and investors are practically begging Verizon (VZ), the nation's largest telecom company, to take MCI off their hands. The Wall Street Journal, which first reported news of the Qwest-MCI talks, said Verizon is holding "exploratory" discussions with MCI. One MCI bondholder said it makes sense for Verizon to buy MCI and that he doesn't know why it hasn't done so yet.
By acquiring MCI, Qwest would solve one of its biggest problems -- its high debt level. Qwest owes $14.7 billion, which amounts to 3.8 times its earnings before interest, taxes, and depreciation, according to a report by telecom analyst David Barden of Banc of America Securities. That's too high. By acquiring MCI, it would add lots of revenue and cash flow and very little money owed, reducing its debt ratio to 2.7 times EBITDA, which is near investment-grade, according to Barden.
SCRAMBLED NETWORKS. The deal also would help Qwest eliminate overlapping jobs and networks, saving millions of dollars in expenses. The business, which started out as a long-distance upstart in the '90s, combined with US West, the smallest of the regional Bells. One person close to the situation said Qwest and MCI could eliminate $6 billion to $7 billion in costs by combining their operations.
The benefits for MCI are smaller and more speculative. The deal would give bondholders and managers an exit, albeit a modest one. And it would help clean up the plethora of networks and billing systems at MCI, which was known as WorldCom until it emerged from bankruptcy last year.
"Theoretically, you would just take all the [MCI] customers and transition them to the Qwest network," says Susan Kalla, telecom analyst with investment firm Friedman, Billings, Ramsey. "The problem with the MCI network is that it's troubled -- there are too many of them, and they need to be integrated. They also have more than 60 billing systems. The Qwest network is new."
FEAR OF BEING ALONE. But the combined company would still be overshadowed by SBC-AT&T. SBC's local phone network is much larger and more lucrative than Qwest's, which extends to just 14 states in the West. And MCI ranks behind AT&T in the sale of telecom services to large corporations.
Many industry analysts believe Verizon -- or possibly BellSouth (BLS) -- is bound to acquire a long-distance outfit. "Now, regardless of the value of a deal, people are jumping in because the worst thing that could happen is to be left alone," says Raul Katz, chief executive of consultant Adventis. He says Verizon CEO Ivan Seidenberg is simply being coy by waiting to make a move on MCI.
Katz adds that MCI and its bankers want to raise the enterprise's value by organizing an auction, similar to the one that led to the acquisition of AT&T Wireless by Cingular, the wireless service provider owned by SBC and BellSouth. "By bringing Qwest in and putting a bid on the table, they [can] go back to BellSouth and Verizon and say, 'What are you willing to give up?'" Katz says.
STAYING SILENT. Verizon declined to comment. But people close to the telco say it has looked at AT&T and other long-distance concerns in the past and decided not to bid. While it could easily afford to buy AT&T or MCI, the issue is whether it can obtain a sufficient return on its investment.
Verizon's stated strategy involves remaking itself as a broadband business, with high-speed wireless and wireline networks. Verizon wants to increase the percentage of revenue that comes from wireless. It's willing to make acquisitions that help achieve that strategy -- if the return on investment is there. Seidenberg told investors last week that the SBC-AT&T deal won't compel Verizon to change its strategy.
Why would Verizon hesitate? The enterprise business, the industry term for the sale of telecom services to large businesses and government agencies, is big -- but not profitable (see BW Online, 1/31/05, "Is SBC Rushing into Trouble?"). And the enterprise businesses at MCI and AT&T are in decline. By acquiring either one, Verizon could eliminate all of its meager revenue growth and put itself into decline for years to come. Verizon's enterprise unit is small, but at least it's growing.
Verizon also could use its resources to try to take full control of Verizon Wireless. The quickly growing venture, owned jointly with Vodafone (VOD), is crucial to its strategy.
It's still entirely possible that Verizon or BellSouth will make a move for MCI or another long-distance carrier. But such an action remains far from inevitable. They're large enough to survive on their own. But Qwest isn't, and that's likely why it's bidding for MCI. With Brian Grow in Atlanta
Rosenbush is a senior writer at BusinessWeek Online in New York