At&T's $11 Billion Bargain
By almost any yardstick, AT&T is paying an astronomical price for Teleport Communications Group Inc. The long-distance giant agreed to fork over more than $11 billion for a company with 1997 revenues just shy of $500 million. That's 22 times revenues when Mergerstat places the average deal last year at 1.5 times revenues. AT&T isn't buying earnings either--Teleport doesn't have any.
Still, news of the acquisition sent AT&T stock soaring 4% on Jan. 8, while the Dow Jones industrial average dropped 1%. So why do analysts and investors think it's a good deal?
First, Teleport gives AT&T local networks in 66 major markets to serve corporations--a business worth an estimated $21 billion. Also, because it can now avoid hundreds of millions of dollars a year in local access charges, AT&T has a chance to compete with lower prices. And it gains the expertise to pursue the larger market for residential local calling at some point. This is what prompted AT&T CEO C. Michael Armstrong to close the deal--after years of unconsummated negotiations between AT&T and Teleport--nine weeks after taking AT&T's top job.
LINK TO CABLE. There's another immediate benefit: Buying Teleport could launch a lucrative relationship between AT&T and the cable industry. Tele-Communications, Cox Communications, and Comcast, majority owners of Teleport, will now become big shareholders in AT&T, since Teleport owners are being paid with 10% of the phone giant's stock.
Already, AT&T is negotiating for a stake in the cable venture @Home, which provides high-speed Internet access through cable modems, to speed up the service it provides through its WorldNet Internet access business. AT&T is also exploring whether it can use the cable infrastructure to provide local telephone service. "There's more to the acquisition than just buying Teleport," says Brian Adamik, a vice-president at Yankee Group Inc.
Still, AT&T is looking for bottom-line results--as much as $2.5 billion a year in cost savings and additional revenue by 2001 from the combination. In 1999, the first full year after the deal closes, the company expects that figure to total $1.1 billion to $1.5 billion, eliminating the dilutive effects of the transaction. In fact, AT&T Chief Financial Officer Daniel Somers calculates the deal will add to 1999 earnings. Analysts have been predicting $3.62 per share for that year.
SOLID STATS. About 70% of that is supposed to come from cost savings, which are fairly easy to quantify. By originating and terminating its customers' phone calls over Teleport's network instead of a Bell network, AT&T will save $500 million to $800 million in access charges in 1999. AT&T will save an additional $220 million to $300 million in 1999 in overhead expenses by, for example, using Teleport's salespeople instead of hiring its own.
The calculations become more speculative when it comes to new revenue from the combined company. AT&T is betting on $330 million to $450 million in 1999 sales that the two wouldn't have gotten if they were operating independently. That calculation is much more art than science. When WorldCom Inc. signed its deal to buy MCI Communications Corp., it didn't factor in such post-merger windfalls. "The revenue synergies are always the hardest to quantify," says Tod A. Jacobs, a Sanford C. Bernstein & Co. analyst.
Still, most analysts--including Jacobs--buy AT&T's math. "Those are pretty reasonable numbers," says James H. Henry, a telecom analyst at Bear Stearns & Co. One factor is the marketing clout AT&T gives Teleport.
Naturally, Armstrong is effusive about his deal. "The opportunity for the AT&T-Teleport merger is immense," the CEO says, adding that AT&T ran several scenarios of potential payoffs from the synergies. And just to make sure nobody got carried away, Armstrong instructed his number-crunchers that their compensation would be based on how well the company was able to realize whichever scenario was ultimately put forward. "They are all going to be held accountable," he says. That's one way to help ensure a merger lives up to its potential.