AT&T, BellSouth in merger talks

A proposal is in the early stages, could fall apart, and may be predicated on AT&T shedding its broadband business, according to industry sources. Furthermore, other suitors could enter the picture. Comcast may soon receive permission to look through the books of AT&T Broadband, according to a Reuters report, as a precursor to a possible deal between those two. That would allow a BellSouth combination with the remainder of AT&T to move forward, sources said.

Representatives for BellSouth and AT&T declined to comment on the rumors. News of the deal was first reported by Business Week.

Such a combination would essentially be a death knell for AT&T--one of the world's most recognizable brands. Saddled with debt because of an expensive foray into the cable business, the telecommunications company already is looking to break apart as a way to focus its efforts.

BellSouth's interest in AT&T's long-distance and business networking operations should come as no surprise. The company was spurned by Sprint when it made acquisition overtures in 1999. Sprint decided to merge with WorldCom, which was scuttled last year once it became evident that regulators would not approve such a combination.

Times have changed, however. The Federal Communications Commission under the leadership of Michael Powell appears to be more receptive to industry consolidation than during the era of former President Bill Clinton. Furthermore, the telecommunications industry is in the midst of a precipitous decline.

"Telecom has fallen on hard times, and regulators would be open to a merger more than they would in the past," said analyst Tom Morabito at McDonald Investments, an equity research and banking firm.

The talks between BellSouth and AT&T are code-named "Brazil," according to sources, with BellSouth surviving the merger and AT&T Chief Executive C. Michael Armstrong leaving at the close of the deal. David Dorman, current president of AT&T, would likely play a large role at the combined company.

Dorman has a history with Baby Bells. He became chief executive of Pacific Bell in 1994 before the company was acquired by SBC Communications. He also has experience with Sprint as well as an ill-fated stint with an outfit called PointCast, which flamed out in the heat of dot-com mania.

Faith in Ma Bell?
The opinion of the merger on Wall Street largely hinges on whether or not you have faith in AT&T's business and consumer long-distance business, a faith that has been tested since growth has retreated in the past few months.

Consumer revenue declined almost 20 percent, 16 percent and 15 percent over the past three quarters from the same respective quarters the year before while business revenue fell about 2 percent, 1 percent, and rose 1 percent over the same three quarters.

This anemic activity tarnishes AT&T's prospects to be acquired in the eyes of potential suitors. "Why would a company that has stable revenue, a stable stock price and positive growth buy a company that would hurt growth," said analyst Drake Johnstone at Davenport & Co., who thinks the deal does not make sense for BellSouth, even though it would instantly make the company a major player in the long-distance market.

BellSouth stock has remained relatively stable over the past year, trading between $50.62 and $36.36 share, while AT&T value has fluctuated more widely between $30 and $16.50 a share.

"AT&T needs to prove that it can stabilize its business," said Johnstone, who argues that BellSouth should wait either for signs of life in AT&T, which would legitimize the takeover, or for a huge discount down the road on the deal if Ma Bell continues to sputter.

Yet, many other analysts on Wall Street hold a different view, pointing out that despite AT&T's negative sales growth, the company still pulls in sizable long-distance profit margins.

In the second quarter, the company reported profit margins--in this case, earnings before taxes, interest, amortization, and one-time items divided by revenue--of 32 percent on its consumer business and 17 percent for its business segment. These numbers are lower than the year-ago quarter's margins of 35 percent and 22 percent, respectively.

"I think BellSouth would be able to get a tremendous asset at a reasonable price," said analyst Doug Christopher at Crowell Weedon, an investment research and stock brokerage firm, who says that long-distance market prices will eventually stabilize.

If that happens, the long-distance segment could act as a cash cow for the merged company, which would make it valuable for investors. "As a standalone business, long-distance revenue is declining, which makes it not as attractive, but it still is a significant cash-flow generator," said McDonald Investments' Morabito.

Regulatory blessing
The merged company would have to gain approval from the FCC, which might look at the merger as an attempt by BellSouth to circumvent present regulations that prohibit local phone companies from selling long-distance until they open their networks to competitors.

"The potential merger creates a huge public policy problem within BellSouth's service territory," said Mark Cooper, director of research at the Consumer Federation of America, a nonprofit research group. "Clearly, there are substantial legal and antitrust issues with any Baby Bell buying AT&T, and there's good reason for that because consumers would lose actual and potential competition."

Under the Telecommunications Act of 1996, regional Bell companies like BellSouth, SBC Communications and Verizon Communications must get approval form each state in their service area that they have opened their networks so competitors can compete with them for local service. In exchange, the so-called Baby Bells could offer long-distance service to customers in their respective territories.

At this time, Verizon has approval to sell long-distance in New York, Connecticut, Massachusetts and Pennsylvania, while SBC gained the FCC's blessing in Texas, Oklahoma and Kansas. BellSouth has not received approval for any state yet.

But charges of anti-competitive behavior might fall upon deaf ears in this climate. Some Wall Street analysts believe the FCC might look upon the merger more kindly, as something that might actually help jump-start the wheezing sector, and that it could spur future mergers between Bells and other long-distance companies like Sprint and WorldCom.