Is BellSouth Just Window Shopping?

Some of its execs want a merger with AT&T, some with Sprint. Another big camp wants to stay solo

As a winning collegiate tennis player, F. Duane Ackerman waited patiently before rushing the net. Longtime friends say the future chairman of BellSouth (BLS ) preferred to rally from the baseline, concealing his own game while tirelessly wearing down his opponent. Only when opponents faltered, revealing a weak backhand or wobbly serve, did Ackerman move in for the kill. In business, as in tennis, the 59-year-old Ackerman has largely kept BellSouth on the baseline. He has focused on the company's traditional voice business in the Southeast while his competitors chased after mega-mergers and invested billions in hot new digital technologies.

Now Ackerman is eyeing the net. In recent months, BellSouth's chief executive has held preliminary merger talks with AT&T (T ), Sprint (FON ), and upstart Williams Communications Group (WCG ), according to former BellSouth executives and two BellSouth insiders. The sources say the Williams deal is dead because the company is too small to add much to the local phone giant, and a deal for AT&T or Sprint won't happen until next year, if at all. Still, Ackerman is seriously considering a blockbuster merger that could remake BellSouth from the stodgiest of the Bells into an industry powerhouse. "BellSouth needs to do something," says Mark Herskovitz, senior sector manager for telecom investments at Dreyfus Corp., which owns 1.2 million shares of BellSouth. "It's just too small."

While going it alone has worked reasonably well so far for Ackerman, the solo path is becoming increasingly difficult. When BellSouth reported third-quarter earnings on Oct. 18, it revealed growing troubles in its business. The number of phone lines in its region, the key indicator of a local phone company's health, dropped 1.4% over the past year, to 25.6 million, as rivals swiped corporate customers and consumers disconnected second telephone lines. As a result, revenue from core telephone operations grew only 4.6% to $4.7 billion, slowing considerably from last year's double-digit growth rate.

DISSENSION? With the pressure on, tensions are rising at BellSouth. While Ackerman and other top execs declined to comment publicly, BusinessWeek has pieced together a behind-the-scenes look through interviews with current and former executives, competitors, and consultants. They say discussions about merger possibilities have split BellSouth's top execs into three camps. One favors a deal with AT&T, another with Sprint. The third and largest would rather see the company remain independent for the foreseeable future.

The debate has strained Bell South's genteel corporate culture. Typically at BellSouth, top execs avoid direct confrontations, letting their subordinates hash out big issues in small informal meetings. At a recent meeting, chief strategist Keith O. Cowan criticized arguments to buy Sprint, according to one person who attended the meeting. Ackerman listened politely to Cowan's critique--then froze him out of the rest of the discussion. So did the 10 or so other executives in the room. "They just ignored him, as if he'd never spoken," says the source. "It was like Cowan had been quietly tarred and feathered." Cowan declined to comment.

Cowan leads a small, outspoken camp that favors a deal with AT&T, insiders say. He wants BellSouth to become a global player and sees AT&T as the best way to make that happen, former execs and outside observers say. With AT&T, BellSouth's revenue would nearly triple to $83 billion, more than any other U.S. telecom player.

The biggest strategic boost would come in serving corporate clients. BellSouth is weak in this market: Less than 10% of its revenue comes from sales to businesses, and it has lost 24% of its business customers to rivals, largely in the past five years. AT&T's business division, with strong offerings in high-speed Net access and Web-site hosting, could help BellSouth stem the loss of existing customers. And once BellSouth wins approval to offer long distance within its region--which is expected to begin early next year--it will have a fresh opportunity to cross-sell AT&T's voice and data services to major companies in the Southeast. That could help boost growth in AT&T's $28 billion business division, where revenues are expected to rise less than 1% this year.

LEADING CONTENDER. The talks with AT&T are the most serious of the merger discussions. They started about two months ago and are now on the back burner while AT&T concentrates on talks to sell its cable-TV business to Comcast Corp., sources inside AT&T and BellSouth say. The talks are expected to resume by January, after the cable deal is done.

A second camp within BellSouth fears AT&T is more swamp than solid ground. To them, AT&T, with its endless management turmoil, would be impossible to meld into the Atlanta-based Bell, with its collegial culture. They also fear the troubles of AT&T's residential long-distance business, where revenues are expected to plunge 20% this year.

This group favors buying Sprint, the country's third-largest long-distance player. The idea was considered as far back as 1999 and championed by C. Sidney Boren, the former head of strategic planning. Today, the group includes David W. Scobey Jr., president of small business services, among others, say insiders. A Sprint deal would boost BellSouth's revenues to $53 billion from $29 billion. More importantly, it would give BellSouth access to Sprint's Internet backbone, the second-largest in the world after WorldCom's. It would give BellSouth entry into the market for corporate services, albeit on a much smaller scale than AT&T. And Sprint's local-phone unit, serving 8 million rural and suburban customers in Texas, Missouri, and 16 other states, would fit nicely with BellSouth's local-phone business and generates about $3 billion a year in cash. The Sprint camp at BellSouth would pass on wireless player Sprint PCS Group, which is smaller than the Cingular wireless venture operated by BellSouth and SBC, one consultant says.

Many BellSouth executives still believe the company should remain independent. Led by Chief Financial Officer Ronald M. Dykes, this camp argues that there's nothing wrong with a company that is posting slow, dependable growth, especially when so many ambitious players are imploding. Indeed, Merrill Lynch & Co. forecasts that BellSouth's revenues will grow about 7% annually through 2004 and net income will increase about 8% yearly. The Dykes camp has been bolstered by a recent internal report prepared by Deloitte Consulting that concluded that the addition of AT&T or Sprint would add little to BellSouth's bottom line until it has regulatory approval to provide long-distance service. "It's hard to make any argument now for BellSouth buying either AT&T or Sprint," says telecom analyst Adam Quinton of Merrill Lynch.

Only Ackerman has the power to break the management logjam within BellSouth, consultants and company executives say. If he does any deal, Ackerman is said to prefer one with AT&T, one person close to the talks says. For all of its problems, AT&T still has the most powerful brand in telecom. And one AT&T source says Ackerman would take some satisfaction in buying BellSouth's former corporate parent and reuniting two pieces of the old Bell System. To accomplish something so historic, Ackerman will have to get aggressive and rush the net.

By Charles Haddad in Atlanta

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