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MCI: Still Up for Grabs

By Christopher Palmeri and Brian Grow The takeover struggle for MCI is going to go another round. Qwest Communications (Q) has decided to continue the fight with a new bid, just days after MCI (MCIP) agreed to be acquired by Verizon Communications (VZ). Qwest Chairman and Chief Executive Richard Notebaert made his plans known in a Feb. 17 letter to MCI Board Chairman Nicholas Katzenbach. The letter was released to the Securities & Exchange Commission.

Details of the new offer weren't immediately clear. But modifications of the last $7.8 billion offer could include more cash or a change in terms of the deal.

In either case, it would set the stage for Notebaert to more aggressively lobby MCI's board and shareholders to block the $6.7 billion Verizon pact. Several large investors have expressed disappointment with MCI's decision to accept a lower offer from Verizon. "The reaction to a new Qwest bid would be very favorable," says Bruce Berkowitz, chief executive officer of Fairholme Capital Management, which owns about 3.5% of MCI's shares. "We're in the second inning of the baseball game."

UNDER PRESSURE. In the letter, Notebaert says Qwest hadn't heard any response to its last offer from MCI. He notes that in addition to offering more money, Qwest is a preferable partner because such a combo would travel on a faster track toward regulatory approval. He also says MCI shareholders would benefit from a Qwest deal because they would own 40% of the merged company. Their stake in a combination with Verizon would be much lower, which means that a higher percentage of profits of a Qwest merger would end up in the pockets of current MCI shareholders.

Qwest, the weakest of the major phone companies, is under tremendous pressure to do a deal with MCI. That would help Qwest lower its debt level in a unique way. MCI emerged from bankruptcy with lots of revenue but very little debt. But Qwest owes $14.7 billion in net debt, or 3.8 times its earnings before interest, taxes, depreciation, and amortization, according to a report by telecom analyst David Barden of Banc of America Securities. By combining with MCI, Qwest would spread its debt over a much larger base, cutting its debt ratio to 2.7 times EBITDA, a level that's near investment-grade.

A telecom industry veteran, Notebaert has played it cool up until now. He made an initial $6.3 billion offer for MCI two weeks ago and upped it a week later. After MCI's board announced that it was accepting Verizon's lower offer on Feb. 14, Notebaert reacted almost stoically, telling investors in a conference call the next day that he had "a great deal of respect for the decision the board made." Since then, Notebaert has resisted any kind of public comment on the deal. Qwest's only reaction was to release the exact terms of its unaccepted offer on Feb. 16.

BATTLE POSITIONS. Qwest could desperately use MCI. Notebaert has been trying to hang on to Qwest's local-phone customers by offering additional new services such as long-distance and Internet access. But he freely admits the local business is under unrelenting competitive pressure from wireless and voice over Internet protocol (VoIP) service providers.

Qwest has no significant wireless business. That leaves Notebaert trying to make something of its massive fiber-optic network. His strategy is to target voice and data services to small and midsize outfits. Buying MCI would allow Notebaert to strengthen Qwest's financial position while giving him access to millions of MCI business customers.

Still, Verizon has the upper hand. With a market valuation of more than $100 billion and a much stronger balance sheet, it could easily up its offer. Expect the battle for MCI to get a lot nastier before it's over. Palmeri is a correspondent in BusinessWeek's Los Angeles bureau, and Grow is a correspondent in the Atlanta bureau

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