How Deep Is The Trouble At Mci?

Losses enrage BT and reveal the weakness at MCI's core

It was a bombshell, all right. At a July 9 board meeting, just 24 hours before disclosing the news to Wall Street, MCI Communications Corp. informed would-be merger partner British Telecommunications PLC, that its fledgling local-service business is on track to lose $800 million this year--twice what had been predicted. Stunned and humiliated, BT CEO Peter L. Bonfield called an emergency board meeting to review the company's pending $20 billion-plus deal with MCI. By the time they met on July 11, MCI's stock had fallen 17.4% and BT's 6.4% on the news.

Small wonder BT and MCI brass were under the gun during a contentious three-hour BT shareholders' meeting on July 16 in Edinburgh. Some angry investors opposed the reelection of MCI Chairman Bert C. Roberts Jr. and CEO Gerald H. Taylor to BT's board and pushed for a renegotiation of the merger. One called for Bonfield's resignation.

SILENCE. What didn't happen at the meeting was equally important: BT did not affirm the deal would go forward, and it did not say it would try to renegotiate the terms. BT also did not make a statement supporting MCI brass--a move that would have squelched reports that BT would demand some MCI heads, perhaps includingthat of President Timothy F. Price.

Industry observers and former BT executives still expect the deal to proceed. But the combination, once hailed as a strategic masterstroke, is now facing setbacks that threaten the combined company's emergence as a transatlantic powerhouse in global communications.

Behind all the drama is a simple fact. MCI is not only far from delivering to BT the local connections to American customers it wants; it is also beset by troubles in other businesses, including market-share losses in its core long-distance business.

MCI management is trying to keep the attention of BT--and other investors--on its woes in local calling. It accuses the Baby Bells of throwing up blockades against potential competitors, and on July 15, MCI's Price called on the Federal Communications Commission to craft new rules to force the Bells to open their markets. The FCC, meanwhile, has announced plans for a task force to look into local competition.

But industry analysts say that few of MCI's woes can be traced to the FCC or even to the Baby Bells. For instance, while MCI complains it is unable to reach agreements to share service with the Bells, competing carriers such as GTE are doing just that. "It's convenient to scapegoat both the Bells and the regulators rather than admit that they're in a rotten strategic pickle," says Scott C. Cleland, an analyst at Legg Mason Wood Walker Inc.

The gist of MCI's strategic problem: It has not successfully diversified beyond long distance. In addition to a disappointing start in local calling, it has a negligible presence in wireless calling. Investments in Rupert Murdoch's News Corp. and a News Corp. satellite enterprise have yielded little. A consumer online service cooked up with Murdoch flopped, and few shoppers flocked to MCI's now defunct online shopping mall. MCI boasts the world's fastest Internet backbone but derives just $200 million a year from Net service sales.

Some analysts chalk this record up to MCI's culture, which evolved around fleet-footed marketing campaigns. "When in doubt, MCI acts," explains Steve Koppman, a senior analyst at Northern Business Information. "Without the emphasis on planning, as the market gets more complicated, it faces more problems with the start-and-stop approach."

Now, MCI is slipping in its core long-distance business, which last year accounted for 91% of revenue and virtually all profits. In the first quarter, MCI's long-distance traffic grew just 4%, while Sprint Corp.'s grew at 14% and WorldCom's grew even faster. MCI's market share is flat at 17.7%. Analysts don't expect local-calling losses to affect second-quarter earnings on July 29--but do expect a 30% drop for the year, to $1.20 a share from $1.70.

Like its archrival, AT&T, MCI is being outmaneuvered by smaller companies such as WorldCom that undercut the big guys on price and jump on new technology sooner. WorldCom subsidiary UUNET Technologies Inc., for example, is threatening to peel off a chunk of long-distance sales by routing faxes over the Internet. Faxes are responsible for 34% of U.S. long-distance traffic, according to Dan Briere, a consultant at TeleChoice. Price says any slowdown in long distance is temporary and that MCI is gaining among high-margin business customers.

If he's wrong, there's not much to fall back on for earnings. MCI has, for example, all but dealt itself out of wireless, the fastest-growing voice phone market. Instead of creating its own wireless network, the company resells calling capacity from competitors such as AT&T and Bell Atlantic Corp. and Nynex Corp. Then there is personal communications service (PCS). Three years ago, MCI sat out the government auctions of spectrum to offer PCS, even though Sprint and AT&T were snapping up licenses for national coverage. MCI's plan was to resell service from NextWave Telecom Inc. But NextWave is struggling to pay off its $4.9 billion auction bid. Meanwhile, MCI's competitors are already launching PCS service.

MCI's investments in direct-broadcast satellites have also yielded little. Since 1995, MCI has invested $1.3 billion in News Corp. and paid $682 million separately for a satellite slot for a subscription service with News Corp. So far, no payoff. "It's premature to fully evaluate this business," says an MCI spokesman.

MCI still offers British Telecom a prominent place in the vast U.S. market, and its heavy investment in local service could eventually pan out. "I still believe the long-term benefits [of pushing into local calling] are going to be worth it," says Bonfield.

But the way MCI disclosed its latest problems to BT has created deep tensions between the companies. And there are signs of disagreements to come over the future of MCI's local-market strategy. BT Finance Director Robert Brace won't comment on whether MCI has agreed to put its plans on hold while BT conducts its review.

Perhaps the most lasting impact of the MCI-BT family crisis may be the strained relationship between the two companies' managers. Bonfield is unlikely to resign, and MCI's Roberts and Taylor will likely be voted back onto BT's board. But MCI's thunderbolt means that at the very least, the honeymoon between MCI and BT is over before anyone has said "I do."

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