MCI Buy Makes Verizon, SBC Head-to-Head Competitors

The merger would also solidify Verizon’s position as the dominant telecom player in the Northeast, giving the combined company a leg up in adding enterprise customers. It also would give Verizon access to MCI’s European network, expanding its reach internationally.

The announcement comes only 2 weeks after SBC agreed to buy AT&T, mainly for its long distance assets and enterprise customers, and makes Verizon and SBC, for the first time direct national competitors. Like the SBC-AT&T deal, the merger will lead to substantial workforce reductions -- as many as 7,000 -- which could prove politically sensitive and pique Capitol Hill interest.

Verizon CEO Ivan Seidenberg said he expects to complete the deal in about a year. “This makes us without question solid #2 in the market with an idea that we can continue to improve and increase our growth rate going forward,” he said. The merger will “accelerate the movements of both companies into the enterprise space,” he told reporters during a news conference.

Along with federal regulators’ scrutiny, reviews are expected by at least some of the states in which Verizon operates. The N.Y. PSC said it plans to do a “thorough review” of the merger “to determine the prudence of this transaction.” The PSC said the Verizon-MCI merger “reflects many of the new realities within the telecommunications arena” such as the development of new technologies and converging markets.

NARUC Telecom Committee Chmn. Bob Nelson of Mich. said the Verizon-MCI merger represents “a monumental change for competitive advocacy in the states and in Washington.” AT&T and MCI were the leading spokesmen for competitive carriers and will no longer be independent companies, he said, which may change competitors’ ability to be heard in Congress and the states. He said NARUC is collecting information from each state regarding their merger review authority and plans to release information on the subject as quickly as it can be gathered. Basically, each state will be asked to describe its review authority so everyone knows where merger reviews can be expected, he said.

FCC staffers told the NARUC Telecom Committee, meeting in Washington Mon., that a substantial part of their time in 2005 will be devoted to review of the 4 major telecom mergers announced in recent weeks -- SBC- AT&T, Verizon-MCI, Sprint-Nextel and Alltel-Western Wireless. Meanwhile, the NARUC Telecom Committee directed its staff to compile a state-by-state description of laws relating to reviews and approvals of telecom mergers and report back at the July NARUC summer meeting in Austin. Michelle Carver of the Wireline Competition Bureau said the SBC-AT&T approval application was expected this month.

Verizon will pay $5.3 billion, including $4.8 billion in stock and cash for all MCI shares, and also pay MCI shareholders a special dividend of $1.46 billion. Verizon will assume about $4 billion in MCI debt. The payment is partly covered by MCI cash in hand.

Qwest had reportedly offered more than $7 billion for MCI. The deal values MCI shares at $20.75, or the price they closed Fri. UBS said Verizon will pay about 4 times MCI’s estimated 2005 EBITDA, versus the 3.9 to be paid by SBC for AT&T. Seidenberg said he isn’t worried about another company making a rival offer. “This is a transaction that goes core to core,” he said. “I'm very comfortable that we have a compelling offer for shareholders and I'm not particularly concerned about somebody coming in over the top.” Qwest “would face an uphill struggle to convince stockholders to dump Verizon,” said Banc of America analyst David Barden.

Verizon officials said that by combining the companies will be able to cut costs $500 million the first year, ramping up to $1 billion in year 3, including the workforce reductions. In year 3 the deal is also slated to become cash flow positive. Just moving Verizon long distance calls to the net will save $100 million per year, officials said.

Analysts See Some Drawbacks

Analysts cited a concern that the merger makes Verizon less of a wireless company as a whole at a time of rapid growth in that sector. Lehman Bros. analyst Blake Bath noted in a report “while synergies alone could pay for the $6 billion price tag in three to five years, we believe Verizon’s deviation from its aggressive wireless strategy would dilute growth.” Bath estimated the acquisition would reduce Verizon’s revenue growth rate to 1.4% from 3.6%.

UBS warned: “While Verizon would be better positioned to exploit the enterprise market within its region, there are a number of drawbacks to such a deal. The deal reduces Verizon’s wireless exposure to 26% of 2006 estimated proportionate sales from 33% as a stand- alone company at a time when the company is looking to increase its exposure to wireless.” UBS also pointed out that the merger is smaller for Verizon than the AT&T deal is for SBC. “AT&T’s equity was valued at $15 billion, roughly 18% of SBC’s $81 billion market value,” UBS said. “At $6.8 billion, MCI’s equity would represent just 7% of Verizon’s $103 billion in market-cap.”

Standard & Poor’s put Verizon on CreditWatch negative, which the firm said “reflects the potential for weaker financial parameters at the company, as well as a possible weakening of Verizon’s overall business risk position.”

The Communications Workers of America expressed concerns about job losses. The merger should provide “new opportunity for workers and a renewed commitment to customers,” CWA said. “That means the creation of quality jobs to ensure that workers and American communities also will benefit from this merger, as well as continued support for universal service, as technology changes the tools we use to communicate.”

The Consumer Federation of America said the Verizon- MCI merger, like others announced recently, will hurt consumers. “Competitive options for residential and small business customers are shrinking, even as state and federal regulators move toward further telecommunications deregulation,” said CFA Research Dir. Mark Cooper.

Heritage research fellow James Gattuso said the merger effectively “closes the books on the long-distance service as an independent industry,” ending the artificial divisions drawn with the breakup of AT&T. Gattuso said he’s not worried about the effect on competition. “Despite claims to the contrary we will no doubt hear, the deal does not mean ‘consolidation’ of the telecom industry,” he said. “Yes, SBC and Verizon will be much larger. And the deal gives both a better foothold in the large business markets, which had been weak points for them. But, the big picture in telecom is still one of more competition, not less.”

Seidenberg said discussions with MCI began in the summer and the companies haven’t reached any agreements on the number of MCI members on the combined board, or what role, if any, top MCI officials may play. Seidenberg said the 2 companies agreed to delay until the coming months discussions of “social” issues. The companies also agreed to a $200 million breakup fee.

Seidenberg described the deal as “simple, straightforward” as well as “aggressive” during the conference call. “This is the right deal at the right time,” Seidenberg said. “We have been evaluating a transaction with MCI for some time, and now we have the opportunity to reach an agreement at the right price.”

MCI CEO Michael Capellas said the pending merger should have no effect on MCI’s already shrinking consumer business, which has been in steady decline since the FCC’s UNE-P decisions. “We will continue to participate in select markets where we have concentrated facilities, but by and large we have been scaling that down for some time,” he said. Asked by a reporter if the merger will put Verizon in the position of operating CLECs, Seidenberg called CLEC service “a business model that has never worked” and said MCI’s CLEC facilities will be integrated into the bigger enterprise business model.

Meanwhile, MCI Mon. reported $5 billion 4th quarter revenue, down 10% from a year ago. Operating income before depreciation and amortization was $775 million. MCI will report full results Feb. 23.