When merger talks between AT&T and SBC Communications Inc. broke off in late June, about $3 billion in market value was created. No, not at AT&T or SBC. The big winner was GTE Corp., where the stock jumped 9%, to 47, before settling back recently to 46. Why? Wall Street is betting that AT&T still wants to buy its way into the local telephone market, and acquiring GTE looks like the best way to do it.
AT&T will have to get in line. GTE, once the homely stepsister of the regional Bells, has blossomed into one of the most desired partners in the big merger dance sweeping the telecom industry. Besides AT&T, Sprint and Cable & Wireless have been mentioned as possible suitors. MCI Communications Corp. talked with GTE about an alliance last year and still is interested. Of all the local telecom companies, "GTE would be the one we would partner with," says Timothy F. Price, MCI president.
GTE Chief Executive Officer Charles R. Lee isn't discouraging such talk, either. That's because even with $21 billion in revenues last year and 20 million telephone lines, Stamford (Conn.)-based GTE may not be big enough to go it alone. Compared with AT&T, MCI-British Telecom, Sprint's alliance with France Telecom and Deutsche Telekom, and even the merged SBC-Pacific Telesis, GTE looks downright puny. That makes it tough for it to go after lucrative business customers, especially those that need an international telecommunications provider. "I'll continue to explore other business arrangements to the extent that they make sense for helping our shareholders," says Lee. "AT&T is our biggest customer. MCI is our second-biggest customer. We talk to [big telecom companies] all the time."
Why is GTE suddenly getting loads of attention? One key reason is that Lee is spending heavily to improve GTE's traditionally weak position in the exploding Internet and data markets. In May, the company agreed to pay $616 million for BBN, which provides Net access for big corporations, such as Hewlett-Packard and Intel, and it has plans to pour $2.5 billion into beefing up its data gear over the next five years. Part of the cash will buy GTE capacity on Qwest Communications Corp.'s 13,000-mile national fiber network. The goal: to offer business and residential customers Net access and high-speed data lines, along with traditional voice service. What's more, the company cut a deal with networking giant Cisco Systems Inc. to jointly design and manage private corporate data networks.
STRONG SUIT. But GTE isn't just riding the Internet wave. Its historical weakness also is becoming a strength--namely, its scattered operations. In 1913, AT&T was forced to stop gobbling up the country's independent phone companies as part of an antitrust settlement. GTE was born out of the leftovers, creating a company in largely rural and suburban markets, hopscotching across 28 states. What had been a costly, inefficient system, though, now offers a key advantage: a national footprint. An acquirer could use GTE's markets as bases from which to launch assaults throughout the country. Today, some two-thirds of the U.S. is within 100 miles of GTE's turf. "None of the [regional Bell operating companies] has that kind of footprint," says Tom Aust, senior telecommunications analyst for Citicorp Securities Inc.
Another advantage GTE has over the Bells: It's getting into long distance now--while the Bells need to wait for the regulatory approval required under the Telecommunications Reform Act passed last year. Since starting to offer long distance 17 months ago, GTE has signed up 1.3 million customers. Meanwhile, GTE's local markets are more protected than most. "Since they're in second-tier markets, competition is going to get there a little more slowly," says Richard H. Brown, CEO of Cable & Wireless PLC, who declined to comment on whether his company is interested in GTE.
Lee, who came to GTE in 1983 as chief financial officer from Columbia Pictures and rose to CEO in 1992, has already done a good job of sprucing up profits. Earnings before extraordinary charges rose 10% last year, to $2.8 billion. Since '92, profits have surged 56%. But sales since '92 rose a slim 9%, to $21 billion. Now, Lee, 57, wants to drive revenues to $38 billion by 2001. "We're basically changing this company from being a good, strong performer...to becoming a growth company," he says.
That growth will come at a cost. Spending on data services and local marketing will likely depress earnings for the next two years. Net income is expected to drop to $2.77 billion this year, from $2.98 billion in 1996, says Frank J. Governali of Credit Suisse First Boston. Still, most think Lee is on the right course. "The impact on earnings will be dilutive, but the strategy will enhance long-term competitiveness," says analyst Jeff Silverman of First Union Corp., which holds 5.4 million GTE shares.
For Lee's plan to work, though, he must squeeze growth out of GTE's local operations, which account for almost two-thirds of revenues. Last month, GTE used a regulatory loophole to split its local service into regulated and unregulated divisions. The regulated company will offer plain-vanilla phone service at regulated prices. The unregulated company will develop new services and pricing strategies to sell bundled services outside GTE's franchise area.
One example of what the unregulated unit can do: In June, GTE teamed up with Microsoft Corp. to sell unified messaging for voice, fax, and E-mail in Tampa and Dallas. If all goes well, the service will be rolled out throughout the country early next year. "The strategy is to cannibalize your own network and poach on the RBOCs in hopes of capturing a larger return," says Citicorp's Aust. "That is a risky, but sophisticated, response to the [Federal Communications Commission] screwing up local phone deregulation."
IT'S WORKING. The unregulated division's main focus will be small and midsize businesses within 100 miles of its territory. "We have to be fast and perform under market-driven models that are not based on traditional monopoly rules and time lines," says Lew Wilks, president of the new competitive local company, GTE Communications Corp. That allows GTE to capitalize on having a familiar brand, spend less on marketing, and save on network installation.
It's starting to work. Debbie Johnston, financial director of Feldman Orthodontics in Tampa, decided to switch long-distance service from AT&T to GTE last year. Her 24-person office racks up about $3,025 in phone bills each month for high-speed ISDN lines, cellular phones, local, and long-distance service. "I figure we save about $200 or $300 a month by doing it altogether with GTE," she says.
But going after Big Business will be a lot tougher. With its rural base, GTE doesn't have a presence in most major metropolitan areas or much experience with Corporate America. A marquee merger partner--such as AT&T or MCI--could make a difference in wooing big corporations. GTE could also use some help in repairing the image problem it has with its bread-and-butter residential customers. It ranked dead last in a J.D. Power & Associates Inc. survey on consumer preferences last year.
Still, Lee thinks GTE's future is bright. With the company's push into the Internet and long distance, he expects sales to increase by 10% to 12% a year starting in 1998, from its historical 6% to 8% range--and perhaps even higher. "We would hope to do better," he says.
He has reason to be confident. Although the telecom industry is getting more cutthroat, Lee probably won't be going it alone.