Qwest may prevail in MCI bid
Qwest may prevail in MCI bidby Chris Nolter Posted 04:34 EST, 18, Feb 2005
As Qwest Communications International Inc. chief Richard Notebaert tries to wrest MCI Inc. from the friendly clutches of Verizon Communications Inc., the executive has a tough but important sell.
Qwest's $8 billion offer well exceeds Verizon's $6.75 million buyout, and the company made public its intention to modify the bid. Large shareholders of MCI have shown interest, but Notebaert will have to assuage deeper concerns that CEO Michael Capellas and the board of the Ashburn, Va.-based target must be weighing.
"The recent disclosures from Qwest are signs of the severe challenges we see the telecom company facing as a standalone entity, with a highly leveraged balance sheet and ongoing operating losses," said Standard & Poor's analyst Todd Rosenbluth. Indeed, Qwest has about $17 billion in debt, and its leverage comes to 4 times Ebitda or higher.
The other Bells have multiples of less than two.
MCI represents perhaps the last opportunity for Qwest to add scale. Tim Horan of CIBC World Markets wrote Friday in a research note that "we believe Qwest is in a very difficult bind and needs a deal."
MCI's biggest rival, AT&T Corp. of Bedminster, N.J., is being acquired by San Antonio-based SBC Communications Inc. and will benefit from greatly increased heft. Paired with Verizon, MCI would present a strong challenger, with local networks in cities like Washington and New York, and a large wireless operation.
Some of MCI's shareholders have criticized the Verizon offer, saying it undervalues the company. "The board of directors of MCI has abandoned its fiduciary responsibility to its shareholders," said David Ahl, an independent analyst in Northern Virginia. "The shareholders of MCI have studied the company and the industry, and reached the conclusion that MCI is worth more than the Verizon offer," he added. "The board of directors should give them the opportunity to vote on the Qwest offer."
An MCI spokesman responded, "After an exhaustive review of all the options on the table, we're confident that our board made the right decision shareholders customers and employees."
Qwest does not have a wireless unit and operates in fewer large cities. "If you look at a combined Qwest and MCI going up against a combined SBC and AT&T, then Qwest and MCI make a pretty weak competitor in almost any market, consumer, small-to-medium-sized business or corporate," said Jay Pultz of the Stamford, Conn., firm Gartner Inc.
Moreover, while MCI has built a $6 billion cash hoard, it needs to significantly improve its profitability. AT&T's Ebitda margins are above 20%, while MCI's are about 10%. Verizon would be better equipped than Qwest to fund new investments.
"It also appears that Verizon was poised to spend a significant amount of capital to get MCI back into shape, investments that [Qwest] would be hard-put to match," Horan wrote. Verizon has pledged to spend $3 billion to $3.5 billion to maintain and upgrade MCI's network in the three years following the buyout — a difficult task.
"I suspect that either Verizon or Qwest are going to find out they have a bigger integration effort, a bigger job, at cleaning up and integrating MCI than they expected," said Pultz. While the telecom has upgraded the core of its network, Pultz says there are legacy assets at the edges of its systems.
"Think of a network as two parts, the network itself and then all the business systems you need around for customers to order things, to be able to bill them properly to troubleshoot problems and all that stuff," Pultz explained. "What MCI still has is a lot of non-integrated systems and a real problem on the IT side that leads to lower service levels and much higher costs."
Qwest has said that a review of its deal would take significantly less time than a Verizon transaction. But Blair Levin, a former Federal Communication Commission chief of staff now at the Baltimore firm Legg Mason, noted that such predictions are fraught with difficulty.
In a Friday note, Levin said that Legg Mason is "skeptical of Qwest's arguments that it could be expected to usher a proposed merger with MCI through the government review six months quicker than Verizon." Levin then noted that the two deals present some of the same regulatory issues.
Working in Qwest's favor, however, is the fact that Verizon doesn't need a transaction to remain a viable company. Several analysts suggested that the company would remain a stand alone company, rather than increase its bid by $1 billion.
"I suspect if Qwest won, the combination wouldn't remain an independent company for more than a couple of years," said Pultz, noting that Verizon itself could pursue the company after some time.
Verizon's alternatives would include a hostile bid for Overland Park, Kans.-based Sprint Corp., which has a pending $35 billion merger with Nextel Communications Inc. of Reston, Va. It could also try to break up SBC's $22 billion acquisition of AT&T.
Verizon's deal with MCI carries a $200 million breakup fee, so the telecom would have some extra cash on its hands if Qwest prevails in its quest. However, the Sprint-Nextel and SBC-AT&T deals have termination fees of $1 billion and $560 million, respectively.
As Qwest Communications International Inc. chief Richard Notebaert tries to wrest MCI Inc. from the friendly clutches of Verizon Communications Inc., the executive has a tough but important sell.
Qwest's $8 billion offer well exceeds Verizon's $6.75 million buyout, and the company made public its intention to modify the bid. Large shareholders of MCI have shown interest, but Notebaert will have to assuage deeper concerns that CEO Michael Capellas and the board of the Ashburn, Va.-based target must be weighing.
"The recent disclosures from Qwest are signs of the severe challenges we see the telecom company facing as a standalone entity, with a highly leveraged balance sheet and ongoing operating losses," said Standard & Poor's analyst Todd Rosenbluth. Indeed, Qwest has about $17 billion in debt, and its leverage comes to 4 times Ebitda or higher.
The other Bells have multiples of less than two.
MCI represents perhaps the last opportunity for Qwest to add scale. Tim Horan of CIBC World Markets wrote Friday in a research note that "we believe Qwest is in a very difficult bind and needs a deal."
MCI's biggest rival, AT&T Corp. of Bedminster, N.J., is being acquired by San Antonio-based SBC Communications Inc. and will benefit from greatly increased heft. Paired with Verizon, MCI would present a strong challenger, with local networks in cities like Washington and New York, and a large wireless operation.
Some of MCI's shareholders have criticized the Verizon offer, saying it undervalues the company. "The board of directors of MCI has abandoned its fiduciary responsibility to its shareholders," said David Ahl, an independent analyst in Northern Virginia. "The shareholders of MCI have studied the company and the industry, and reached the conclusion that MCI is worth more than the Verizon offer," he added. "The board of directors should give them the opportunity to vote on the Qwest offer."
An MCI spokesman responded, "After an exhaustive review of all the options on the table, we're confident that our board made the right decision shareholders customers and employees."
Qwest does not have a wireless unit and operates in fewer large cities. "If you look at a combined Qwest and MCI going up against a combined SBC and AT&T, then Qwest and MCI make a pretty weak competitor in almost any market, consumer, small-to-medium-sized business or corporate," said Jay Pultz of the Stamford, Conn., firm Gartner Inc.
Moreover, while MCI has built a $6 billion cash hoard, it needs to significantly improve its profitability. AT&T's Ebitda margins are above 20%, while MCI's are about 10%. Verizon would be better equipped than Qwest to fund new investments.
"It also appears that Verizon was poised to spend a significant amount of capital to get MCI back into shape, investments that [Qwest] would be hard-put to match," Horan wrote. Verizon has pledged to spend $3 billion to $3.5 billion to maintain and upgrade MCI's network in the three years following the buyout — a difficult task.
"I suspect that either Verizon or Qwest are going to find out they have a bigger integration effort, a bigger job, at cleaning up and integrating MCI than they expected," said Pultz. While the telecom has upgraded the core of its network, Pultz says there are legacy assets at the edges of its systems.
"Think of a network as two parts, the network itself and then all the business systems you need around for customers to order things, to be able to bill them properly to troubleshoot problems and all that stuff," Pultz explained. "What MCI still has is a lot of non-integrated systems and a real problem on the IT side that leads to lower service levels and much higher costs."
Qwest has said that a review of its deal would take significantly less time than a Verizon transaction. But Blair Levin, a former Federal Communication Commission chief of staff now at the Baltimore firm Legg Mason, noted that such predictions are fraught with difficulty.
In a Friday note, Levin said that Legg Mason is "skeptical of Qwest's arguments that it could be expected to usher a proposed merger with MCI through the government review six months quicker than Verizon." Levin then noted that the two deals present some of the same regulatory issues.
Working in Qwest's favor, however, is the fact that Verizon doesn't need a transaction to remain a viable company. Several analysts suggested that the company would remain a stand alone company, rather than increase its bid by $1 billion.
"I suspect if Qwest won, the combination wouldn't remain an independent company for more than a couple of years," said Pultz, noting that Verizon itself could pursue the company after some time.
Verizon's alternatives would include a hostile bid for Overland Park, Kans.-based Sprint Corp., which has a pending $35 billion merger with Nextel Communications Inc. of Reston, Va. It could also try to break up SBC's $22 billion acquisition of AT&T.
Verizon's deal with MCI carries a $200 million breakup fee, so the telecom would have some extra cash on its hands if Qwest prevails in its quest. However, the Sprint-Nextel and SBC-AT&T deals have termination fees of $1 billion and $560 million, respectively.
