The Return Of Ma Bell?

Talks between AT&T and SBC raise fears of a new monopoly

If there's one thing that Robert E. Allen has learned in the 13 years since the modern AT&T was created from the breakup of the old Bell System, it is the awesome power of competition. Allen, chairman of AT&T for the past nine years, has seen competitors--from MCI Communications and Sprint to tiny dial-around companies--steal market share. He has watched price wars corrode his profits and depress his stock. Allen's conclusion: The way to get AT&T back on track was to play the aggressor in a market still untouched by competition--local calling. The Telecommunications Act of 1996 opened the regulatory door, and some promising wireless technology acquired with McCaw Cellular Communications Inc. in 1994 gave Allen the means.

It turns out that breaking into the local phone market isn't so easy, though. Creating a system that can go up against the local Baby Bell will take far longer and be much costlier than originally envisioned. Building local networks will cost AT&T $9 billion this year alone, a 50% increase over prior capital spending levels. Alternate methods--such as reselling local service--offer low return. Meanwhile, AT&T's attempts to stem its slide in long distance have largely failed, and investors are screaming about a share price that has been trending down for the past year.

That's what led Allen to pursue merger talks with SBC Communications Inc., the San Antonio-based Baby Bell made up of the former Southwestern Bell Corp. and Pacific Telesis Group. Instead of waging a decade-long campaign to break into local calling as an upstart competitor, AT&T now contemplates an instant grab for one-third of the local phone lines in the country and--more important--the hefty profits that SBC garners from the virtual monopoly it and other local phone companies retain.

News of the proposed $50 billion-plus merger, by far the largest corporate combination in history, shocked the industry. Sources close to the talks say the two companies still are wrestling with financial and regulatory issues--and the conformation of the $80 billion behemoth that would emerge. Industry analysts are betting that SBC execs will wind up in charge and that newly installed AT&T President and Chief Operating Officer John R. Walter will be out.

Even if the talks don't wind up with a deal--or if a merger is blocked by federal antitrust enforcers, as many observers predict--the fact that these giants are talking at all is hugely significant. This is a deal that could forever change the business.

"QUICK HIT." For AT&T, it is at minimum a way to let Allen retire on schedule in May, 1998, on a high note. "The attraction is the quick hit--you can cut costs and pump up earnings for a few years," says Worldcom Chairman James Q. Crowe, whose company just absorbed MFS Communications Co.

But would it be a good deal for consumers? And will it accelerate a pattern of massive consolidation in the telecom industry? "This deal would almost precisely put back together for 8 or 10 states the situation that the Justice Dept. broke up" in 1984, when AT&T agreed to spin off its local service companies, says Donald I. Baker, a senior partner in the Washington law firm of Baker & Miller and head of the Justice Dept.'s Antitrust Div. in the Ford and Carter Administrations.

In some ways, the AT&T-SBC combo might be even more powerful. AT&T is the top long-distance company, and SBC, since its takeover of PacTel, is the No.2 Baby Bell. In addition, AT&T and SBC are, respectively, No.1 and No.2 in wireless communications.

And, analysts predict, where AT&T leads, rivals are bound to follow. "We are heading toward four or five mini-Ma Bells, and I think that's a shame," says Joseph A. Noel of Hambrecht & Quist. Noel and other critics of the deal note that long-distance rates have dropped some 75% and innovation has flourished since the breakup of the Bell System, while local rates have dropped little.

This hardly was the intent when, a year ago, the U.S. dismantled 100 years of telecom regulation. The landmark Telecommunications Act of 1996 aimed to produce more competition in U.S. telecommunications and broadcasting markets than in any other nation. But as the proposed AT&T-SBC deal points up, there has been little change in local calling: The costs of launching a new local-calling network are so high that competition remains all but nonexistent in most markets.

Policymakers had expected some industry consolidation--and got it in spades. Just 19 days after President Clinton signed the telecom reform bill, U S West Inc. announced it would buy Continental Cablevision for $10.8 billion. SBC then launched its $16.7 billion bid for Pacific Telesis and two East Coast giants--Bell Atlantic and Nynex--began planning their $23 billion merger.

An AT&T-SBC combination, however, pushes the envelope. Unlike the mergers that have gone before, SBC and AT&T already have overlapping businesses and could, in a single stroke, eliminate the largest prospective competitors in their markets. A Yankee Group Inc. survey found that two-thirds of consumers would like to deal with a single phone company for local and long distance, with 40% of respondents choosing AT&T as the provider and 40% choosing the local incumbent. "That gives AT&T-SBC an 80% market share off the bat," says Yankee consultant Brian Adamik.

GLOBAL CLOUT. That's one reason the merger could hit regulatory trouble. "I just don't see how this could happen from an antitrust point of view," says Linda B. Meltzer, UBS Securities analyst. The Justice Dept.'s antitrust staff "spent 20 years breaking up and monitoring the breakup of the old AT&T," says Washington antitrust attorney Joseph Sims. "The mind-set of the staff people would be, `We know what all the problems were. We just fixed them all. We want to make sure we don't recreate them."'

AT&T's most likely line of defense will be to point to competition beyond U.S. borders. It can argue that an AT&T-SBC deal would produce a company with the clout to compete against international giants such as Deutsche Telekom, Japan's NTT, and British Telecommunications, which is about to take over MCI, AT&T's archrival in long distance. Says one antitrust lawyer: "The Justice Dept. may view this as a global market, where size matters."

Even if an AT&T-SBC marriage fails to win antitrust and regulatory approvals, the industrywide mating dance will no doubt continue. GTE, Ameritech, and BellSouth, for example, are beginning to look like merger targets. "They've got to be saying to themselves, or shareholders should be saying to them: `Where is growth going to be coming from for you?"' says Robert Fox, director of the telecommunications practice at Mercer Management Consulting Inc. Ameritech is weak in the fast-growing wireless business, while BellSouth may be relying too heavily on the Sun Belt's prosperity, which may not last forever.

GTE, say many analysts, is the most likely takeover candidate. Once the largest local phone company, it will soon be third after SBC and Bell Atlantic-Nynex. As for a merger, says CEO Charles R. Lee: "We don't rule out anything."

Nor should he--if he wants to stay in the game. "The telecom act has not ended up being about a lot of new competitors," says a Washington attorney close to both AT&T and SBC. "It's about removing barriers so the big players can do more--fewer players offering more services." It may not have been the intent of Congress, but it's the reality.

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