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Takeover Hostility for MCI

By Steve Rosenbush and Brian Grow The battle for MCI entered a critical new stage on Apr. 4, as Verizon issued a written ultimatum: If MCI embraces an $8.9 billion offer from Qwest Communications, Verizon will stop bidding for the pioneering telecom company.

Qwest's (Q) latest offer was made Mar. 31, two days after MCI (MCIP) agreed to Verizon's (VZ) most recent $7.6 billion bid. Qwest's later offer is 19% higher than Verizon's, and it appears that Verizon is growing tired of waiting for MCI to decide that Qwest's bid is inferior in quality. Verizon would pay for two-thirds of its purchase with stock, while Qwest would pay about half with stock. Verizon is betting that it will win because investors consider the value of its "currency" far more stable than Qwest's.

The battle may come to a head at midnight Apr. 5, when Qwest's offer for MCI is set to expire. MCI's board is expected to meet on Apr. 4 to consider the offers, people close to MCI say. And Verizon is starting to use tough language: "If the MCI board, capitulating to Qwest's artificial deadline, declares this bid to be 'superior,' it would seem to us that the decision-making process is being driven by the interests of short-term investors rather than the company's long-term strength and viability. Should this occur, we would no longer be interested in participating in such a process," it warned in a five-page press release issued late on the afternoon of Apr. 4.

CALLING A BLUFF? Verizon CEO Ivan Seidenberg has indicated that he's unwilling to continue a bidding war. Verizon "just [isn't] going to play this game anymore, bidding against a company that keeps pumping out Confederate currency. The dynamic has changed," one person familiar with the talks says.

Chances are good that MCI will call Qwest's bluff by ignoring its midnight deadline. In that case, Qwest CEO Richard Notebaert will probably take his case directly to MCI shareholders in an all-out proxy battle. "What does the board think it will take to win over shareholders? The highest bid," one person close to the MCI board says. But, this individual adds: "The board would be remiss if it didn't try to calculate which price would be better on the closing date."

Some experts say Qwest's proposal already looks too expensive -- it's offering more than five times the value of MCI's earnings before income taxes, interest, depreciation, and amortization (EBITDA). By way of comparison, SBC's (SBC) agreement to buy MCI's bigger and stronger rival, AT&T (T) is based on a multiple of less than four times EBITDA, according to financial firm UBS.

AGED NETWORK. Qwest desperately needs to buy MCI, though. The deal would greatly improve Qwest's debt profile. By spreading its liabilities over a much larger revenue base, the company says it could even regain an investment-grade credit rating. Qwest justifies a high price by saying it could cut nearly $15 billion in costs by combining its long-distance network with MCI's. That's about twice the savings Verizon promises. And Qwest argues that's because Verizon is a local phone giant with less operational overlap, so it can hope to achieve only about half as many cost reductions.

Verizon, though, is insisting that Qwest won't be able to deliver on its promises because MCI's network needs an overhaul. MCI, which was previously known as WorldCom, survived both the largest bankruptcy and the largest accounting scandal in history. The impact of those events slowed capital investment to a crawl. Verizon says it will need to spend $3 billion to bring the MCI network up to date.

"It is clear that MCI's core IT and network infrastructure requires immediate investment, a need that Qwest has not acknowledged and apparently has no plans to address," Seidenberg said in an Apr. 4 letter to MCI board Chairman Nicholas deB. Katzenbach and CEO Michael Capellas.

"ACT OF DESPERATION." Qwest counters that Verizon is trying to prevent a full and fair auction for MCI. "Once again, Verizon has attempted to thwart the merger process by threatening the MCI board into disregarding a superior proposal or risk the consequences of Verizon abandoning MCI and terminating its offer," Qwest spokesman Tyler Gronbach says.

A few shareholders cheered Verizon's threatened departure. "In my opinion, it's an act of desperation," says Leon G. Cooperman, founder of Omega Advisors, which owns about 3% of MCI's outstanding shares. "In the capitalist system, the highest offer should win. I'm tired of hearing about hedge fund this, hedge fund that. We're not short-term investors. Our investment in MCI predated any merger activity. Qwest and Verizon should both stop crying and let the highest offer win."

And John Paulson, president of Paulson & Co, a New York-based investment firm that owns 3.5% of MCI, said he would be glad if Verizon withdrew.

NOTHING FRIENDLY. Investors will scrutinize Qwest's share price for clues to the outcome of the battle. Carl Schecter, managing director and head of risk arbitrage at Nomura Securities International, says: "If Qwest's stock holds up, then it's a strong candidate [to win]." Qwest shares rose 18 cents, to $3.82 on Apr. 4.

The battle for MCI may not technically qualify as a hostile takeover. But the level of acrimony is so high, that even a friendly offer from Verizon now has the aura of hostility about it. With Christopher Palmeri in Los Angeles

Rosenbush is a senior writer for BusinessWeek Online in New York and Grow is a correspondent in BusinessWeek's Atlanta bureau

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