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WorldCom-MCI scrutiny heats up

The proposed merger is being looked at by an increasing number of authorities.

Like Microsoft's domination of the market for PC operating systems, the proposed merger between WorldCom (WCOM) and MCI Communications (MCIC) is drawing scrutiny from an increasing number of authorities.

Last week, a number of new groups confirmed that they are stepping up their investigations of the $37 billion merger. They are concerned that it would have an anticompetitive effect on the Internet backbone industry, which is responsible for routing high volumes of data across a worldwide network. In addition to a beefed-up investigation by the Justice Department, 15 state attorneys general also are sharing information about potential antitrust effects, and the European Commission is studying the deal as well.

Opposition by private groups is increasing, too. Last week, consumer advocate Ralph Nader joined the Communications Workers of America in voicing opposition to the proposed merger. Companies such as GTE, Sprint, and PSINet stepped up criticism as well.

The criticism from almost every group is virtually the same. The deal, they say, will increase prices and disrupt a delicate balance that, thus far, has allowed the Internet to thrive.

In order to survive under the current circumstances, companies providing high-capacity Internet services are required to cooperate with each other--even as they compete. So-called peering agreements are ubiquitous in the industry, and allow for companies such as MCI and Sprint to exchange data so that traffic flows efficiently across the Internet. Opponents say they are concerned that the merger would significantly change the peering model.

"If WorldCom-MCI has a share of 45 percent or more [of the backbone traffic], their incentives to interchange traffic with other backbones change dramatically," said Mark Schechter, an outside attorney for GTE. "It gets to the point where no cooperation is more profitable then cooperating."

But the industry, which so far has flourished under the lack of government oversight, is aware that any remedy could be a double-edged sword. Schechter said GTE opposes the merger outright, noting that any regulatory scheme that might alternatively be imposed on the industry would have a "perverse result."

Bill Schrader, chairman and chief executive of PSINet, said he, too, was concerned about merger, but added that "probably the worst case is if the DOJ institutes a regulatory framework for the Internet. This would be the end of the most innovative environment ever created." Schrader called on the Justice Department to scrutinize the merger, but said he did not want the agency to block it or impose regulatory conditions on it.

His point apparently is not lost on authorities investigating the proposed deal.

"We're not trying to stop the merger," said Robb McBurney, a spokesman for South Carolina Attorney General Charlie Condon, who along with Virginia Attorney General Mark Earley called on other states to jointly investigate the matter. "We're trying to prevent what could conceivably become an anticompetitive merger."

McBurney said 15 states have formed a working group to swap information. He declined to say who the other states are.

For their part, MCI and WorldCom deny that their union would wreak anticompetitive havoc on the backbone market, and predict that they will receive approval by midyear. McBurney said it was impossible to know when his states and other agencies will finish their investigation, but said "it is possible they could hold [the merger] up."

Joe Sims, an antitrust attorney at Jones, Day Reavis & Pogue, said a number of factors make the merger inquiry more challenging than most.

"Because this is an unregulated business and a relatively new one, there's not a lot of information out there," Sims explained. Investigators "have to gather information piece by piece."

To that end, a host of Internet backbone providers confirmed last week that the Justice Department had issued them detailed civil subpoenas in an attempt to measure the proportion of traffic that moves across various companies' networks.

Another difficult issue authorities must wrestle with, said Sims, is adapting traditional antitrust analyses concerning market power to such a new industry. As a result, he said, much of the investigation will center around how easily backbone networks can be created.

"If [the merged company] owns all the capacity, or enough of it, and it's not likely that new capacity could come online in a timely manner, then they probably would be able to raise prices profitably, and that would be a merger the department would likely oppose," said Sims, who once served as an assistant attorney general with the Justice Department

But despite the complexity of the probe, Sims said, MCI and WorldCom's projection that the deal will be approved by mid year is not unrealistic.

Indeed, all the negative attention WorldCom has received of late seems to be having little impact on its stock--the company's shares continue to rise. Salomon Smith Barney analyst Jack Grubman today upgraded WorldCom to "strong buy" and projected that shares would rise 142 percent over the next 30 months. In early afternoon trading, the stock was at 41-13/16, up more than 6 percent from Friday's close.