[February 14, 2005]

Verizon-MCI Deal Doesn�t Guarantee Growth, Analysts Say

BY JOHANNE TORRES

Today’s announcement of Verizon acquiring MCI for more than $6.75 billion, after the latter rejected Qwest’s higher bid of $7.3 billion, doesn’t necessarily make room for new growth, The Yankee Group’s analysts say. The research firm believes that the main drivers behind today's deal is access to the enterprise market, cost savings and scale—just as the reason behind SBC acquiring AT&T. Because MCI's core wireline businesses remain anemic, say analysts, it continues to experience declining revenues—The Yankee Group doesn't expect this deal to drive new growth.

The Yankee Group said in an official statement that it assumes MCI has cleared this bold move with its top shareholders. So, setting aside the issue of shareholder objections, the research firm sees several implications resulting from the deal:

Analysts see Qwest's next move being: With AT&T and MCI out of play, Qwest has limited options. Sprint is an unlikely candidate given its efforts to focus more on wireless markets and new expensive capital structure. The next tier of providers includes smaller scale companies with CLEC roots that target SMBs, such as Broadwing, XO and TelCove/KMC. Considering Qwest's nationwide network and midmarket business unit, a move in this space makes sense but lacks MCI's scale and market access. Also, MCI, with its $5.5 billion in cash, would bring a much better capital structure than most of these arrangements.

The Yankee Group believes that as Verizon gains access to a national, complex data network market: MCI's core strength is its knowledge of the large business market, characterized by demand for complex corporate data services. This segment drives approximately $28 billion in revenue. Verizon has been executing on a strategy of penetrating this market via its Enterprise Services Group (ESG). But ESG's strength lies in its in-region capabilities. In most deals, less than 30% of the contract value is derived from selling out of region solutions. Therefore, the MCI acquisition will allow ESG to overcome this limitation and attack the market as one integrated company. Furthermore, MCI has 91 sales offices across the United States, access to the federal government and is the second largest provider to multinational companies, next to AT&T.

Analysts see cost synergies for Verizon and MCI: Expect Verizon and MCI to justify the deal on cost synergies. For example, Verizon will likely pull back from building its own MPLS network and use MCI's network instead. MCI is a Cisco Powered Network partner with significant growth of its MPLS-based private IP network. Also, by using the MCI backbone for its long-distance and wireless traffic Verizon will save money. This will bring a new source of revenue to MCI, since it currently is not a significant wholesale supplier to Verizon. However, it will also mean a loss of revenue for Verizon's existing wholesale suppliers.

Experts see Verizon entering the VoIP business market: MCI was the first to launch a network-based, hosted VoIP offering in July 2002. MCI Advantage targets midsize businesses, but has met with very limited success. However, since Verizon hasn't formally launched its own hosted platform, it will gain from MCI's experience and knowledge in this strategic product area. Furthermore, MCI is considered a leader in the development of advanced VoIP technologies such as SIP and ENUM.

The Yankee Group’s report unveils that Verizon could offer an end-to-end international network: In the third quarter of 2004, MCI reported nearly $1 billion in international revenue--much of it from European business--which extends to 140 countries. This operation provides local access services throughout Europe's main financial centers and primarily competes with local incumbents and competitive carriers, such as COLT. Verizon will need to decide whether to maintain this line of business. The numerous multinational companies with a presence in Verizon's territory may mean that it can now offer cost effective end-to-end service.

The research firm believes that Verizon's competitive focus on SBC and the enterprise market drove this deal—and like the SBC and AT&T acquisition, it will be sustained by cost synergies. Analysts see that in the long term, this was a good move by Verizon. According to The Yankee Group’s report, the excess costs removed from the market will result in healthier businesses and revenue streams.

The Yankee Group
www.yankeegroup.com