[March 1, 2005]

The Buzz on MCI-Qwest-Verizon

By David Sims, TMCnet CRM Alert Columnist

The news this morning is that Qwest Communications International Inc. is claiming it can generate cost reductions valued at $14.8 billion from a merger with long-distance telephone company MCI Inc., including up to 15,000 job cuts.

In slides prepared for the analyst meeting this morning, Qwest says it can cut annual costs of a merged Qwest-MCI by $2.5 billion to $2.9 billion, according to the Associated Press. It claims the merger would allow it to use tax credits for earnings, saving another $2 billion.

“Qwest said the savings would include between 12,000 and 15,000 job cuts, equal to 15 percent to 18 percent of the combined company’s work force… MCI may meet with Qwest to discuss the suitor’s revised takeover bid to assure shareholders it has explored all options and tried to clinch the best offer,” the AP reports its sources familiar with the situation said Monday.

Forbes magazine notes that while “ In the past two weeks industry seniors Qwest Communications International and Verizon Communications have given MCI more attention than a freshman cheerleader gets in September,” Verizon, in the long run, “has more to offer MCI.”

Forbes rattled off a list including better financial resources, a less volatile stock and the prospect of entering a huge wireless market being “just a few” reasons while Verizon makes more sense for MCI. Plus, “with Qwest’s ability to come up with the money for an acquisition being called into question, a shrinking customer base and massive debt are even less enticing qualities in a potential suitor.”

Qwest has spent months wooing the former WorldCom company, Forbes notes, before it was beaten out by a Verizon bid late in the evening on Feb. 13: “Maybe the rumors about MCI Chief ExecutiveMichael D. Capellas only flirting with Qwest to attract a bigger, stronger company were true,” the magazine suggests, “especially considering Verizon’s offer of $6.8 billion in cash was much less than Quest’s $7.3 billion offer.”

Whether MCI was only flirting or not, Qwest is definitely serious about walking MCI down the aisle. MCI announced its engagement to Verizon on February 14 th, and on Feb. 17 Qwest, the No. 4-ranked regional telecom sent a letter to both the U.S. Securities and Exchange Commission and MCI stating its intent to enter another bid to counter Verizon.

As recently as February 25 th Capellas was maintaining in an earnings call that Verizon is “the right partner” for MCI. Nobody expected Qwest to just send a wedding gift and slink away, however. Capellas did say that MCI’s board would perform its fiduciary duty in examining Qwest’s revised $8 billion offer, which exceeds the value of Verizon’s $6.75 billion buyout, leaving some hope, however muted, for Qwest.

CIBC World Markets Corp. analyst Tim Horan expects Verizon to sweeten its bid in response. On January 24 th Qwest had tweaked its bid to include collars that would limit the effect of stock price variations on the deal. “If Verizon raises its bid by this amount,” Horan wrote, “We believe that Qwest will have to increase its offer by $2 per share, and that it could win the auction at that price.”

No matter what the final deal, Motley Fool argues Qwest should at least be taken seriously. “Yeah, I know Qwest is the punk of the Baby Bells,” the Fool writes. “And, yes, I’m aware the firm is destroying shareholder equity. But, contrary to prevailing opinion, a deal with Verizon isn’t a no-brainer. For example, Verizon would take at least a year to close the deal. Qwest CEO Richard Notebaert said in a letter to MCI that his company could do a deal in six months less time.”

There are reasons why a deal with Verizon may be more advantageous even at a lower price tag. New York-based Verizon is much larger than Qwest, and its debt levels are more manageable. Capellas believes firmly in the long-term benefits to investors of the Verizon deal.

Accepting Verizon’s lower bid in the first place “clearly was a balancing of interests that looked at several intangibles beyond price,” says telecom lawyer Andrew Lipman of Swidler Berlin LLP.

One contentious issue for the board of MCI is that different shareholders have different interests. Some of MCI’s most vocal shareholders are hedge funds, which would like a quick payoff. For such investors, says Daniel Bergstein of Paul, Hastings, Janofsky & Walker LLP “The fact that Verizon paper may be worth more to an MCI shareholder two, three, four years down the road — that’s not impressive to the hedge funds.”

MCI’s board could decide that Verizon’s bid is still superior. It could also conduct an auction, either an open process with public disclosure or a closed sale, conducted with less transparency. In an open auction, MCI might see a series of incremental bids. Qwest could also lodge a hostile offer, trying to rally MCI’s shareholders to its side.

There would be a host of legal and other problems with a hostile bid. Still, Qwest may feel that it cannot let MCI get away. Without a deal, the company will be hard pressed to develop heft of larger rivals like Verizon and to reduce its debt levels. Verizon does not face that pressure. As one observer notes, “If Verizon doesn’t do this deal, it isn’t momentous. If Qwest doesn’t do this deal, it may be momentous.”

David Sims is contributing editor and CRM Alert columnist for TMCnet.