By Steve Rosenbush
Just a few years ago, deal-crazy telecom executives generated huge fortunes for investment bankers and analysts. The acquisitive exploits of AT&T (T ), WorldCom, and others made huge headlines and added to the sector's energy and excitement. For a moment on July 12, it was easy to imagine it was happening again.
Investment company Leucadia National (LUK ) said it had filed papers with the Federal Trade Commission announcing its intention to buy more than 50% of fallen telecom star MCI (MCIA ), which has a market cap of about $5 billion. The filing was necessary because Leucadia owns smaller rival Wiltel Communications. The former WorldCom telecom empire adopted the name of its well-known MCI unit last year as it worked its way through a bankruptcy restructuring that was triggered by massive accounting fraud.
The announcement led to conjecture that MCI, long the subject of takeover talk, would soon be engulfed in a wave of rival offers. "There was always takeover speculation. Now, it's for real. This kicks off a bidding war," says telecom analyst Patrick Comack of investment company Guzman & Co., in Miami. He believes MCI is just a small round in a bigger telecom consolidation process, which has been anticipated for several years. Shares of MCI rose $2.50, or about 17%, to $17.10 on June 12.
However, the obstacles to such consolidation remain considerable. Indeed, it's far from certain that Leucadia will trigger a wrestling match for MCI, let alone widespread consolidation of the entire telecom sector.
The basic hole in the consolidation scenario right now: What company would submit a rival bid for MCI? The most likely candidates are phone giants Verizon (VZ ), SBC (SBC ), and BellSouth (BLS ). But these companies, which came through the telecom meltdown intact, are struggling with their own demons, as growth and profitability on the wane. UBS telecom analyst John Hodulik said in a July 12 report that the group's profit margins are expected to fall to 39% this year from 40.8% last year and 41.9% in 2002.
Buying a shrinking long-distance company that has much worse margins than any of the Bells wouldn't address that fundamental problem. BellSouth, for one, insists that it has no interest in buying MCI.
A Bell would have only one reason to want MCI: access to its huge base of big corporate customers. But even this business is troubled. Years of intense competition have pushed margins down in the high-end corporate market. Even AT&T has had difficulty generating revenue growth in this segment.
Why would the Bells buy another problem for themselves? Their real interests are in serving small and midsize businesses, where margins are a little better. And that's a category they can build without the hassle of buying MCI, which has had trouble hitting its financial targets even though it got out from under a ton of debt in bankruptcy court.
Even if Leucadia succeeds in buying MCI, it won't necessarily force big telecom companies into the M&A fray because this deal wouldn't eliminate a competitor. While SBC or Verizon might be forced to make a move if a peer like BellSouth tried to acquire MCI, it hardly matters to them whether MCI is controlled by Leucadia (LUK ) or other investors. So this bid alone isn't likely to be enough to spark massive telecom consolidation.
That doesn't mean a Leucadia-MCI deal would be unimportant. If Leucadia gets hold of MCI, it's likely to sell or shut down desperate divisions like the consumer long-distance unit. It would be much easier, on a political level, for Leucadia to do that than it would be for a Bell. Once Leucadian whittles MCI down to a smaller and more appealing business, it might very well draw the interest of a strategic buyer such as BellSouth, Verizion, or SBC.
MCI isn't such a bargain, either, even though it seems cheap compared to the lofty valuations of old. It's trading at 3 times 2004 earnings, a slight discount to its stronger rival AT&T, which is trading at 3.4 times 2004 earnings, telecom analyst Blake Bath of Lehman Brothers said in a July 12 report. Bath, who noted that MCI and Leucadia don't appear to have engaged in talks, said he was "cautious on the likelihood that this announcement will trigger meaningful consolidation in the industry."
As desirable and appealing as it may be, telecom's go-go era isn't quite ready for a reprise.
With Brian Grow in Atlanta
Rosenbush is a reporter for BusinessWeek Online in New York