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Verizon, MCI to link up in $6.7 billion deal

Valentine's Day betrothal will give regional titan Verizon access to MCI's worldwide long-distance and IP networks.

Marguerite Reardon Former senior reporter
Marguerite Reardon started as a CNET News reporter in 2004, covering cellphone services, broadband, citywide Wi-Fi, the Net neutrality debate and the consolidation of the phone companies.
Marguerite Reardon
6 min read
Verizon Communications has sealed a $6.7 billion deal with long-distance provider MCI as the telecommunications industry continues its spasm of megamergers.

On Monday, Verizon said it will pay $4.8 billion in stock and $488 million in cash for MCI. Verizon will also pay special dividends of $4.50 per share, or nearly $1.5 billion. This makes the total deal for MCI worth more than $6.7 billion.

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The acquisition of MCI comes two weeks after SBC Communications, another Baby Bell, announced it was buying the No. 1 long-distance carrier, AT&T, for $16 billion. The SBC-AT&T deal has changed the telecommunications landscape, pitting the three remaining regional telephone companies--Verizon, BellSouth and Qwest Communications International--against one another in several markets.

The absorption of the two biggest long-distance carriers is further evidence that the telecommunications market is changing in fundamental ways. Telephone companies will have to offer more than just local or long-distance voice services to compete with new rivals such as cable operators and Net-telephony providers.

Merger mania hit the wireless market first. In October, Cingular Wireless completed its acquisition of AT&T Wireless, creating the largest wireless carrier in the United States. Then, in December, Sprint announced a $35 billion merger with Nextel Communications. And in January, Alltel, an independent rural phone company, announced that it was buying regional wireless carrier Western Wireless in a deal worth $6.2 billion.

During a conference call with analysts, Verizon CEO Ivan Seidenberg said his company had been talking to MCI over the past six months or so about a possible acquisition. He added that the market's acceptance of four recent major acquisitions in the wireless and wire-line industry made the timing right.

"MCI is one of the few beachfront properties out there," Seidenberg said. "It would have been crazy for us not to talk to Michael (Capellas, CEO of MCI) about what he and his team were doing. It was a very natural thing for us to do."

What's in it for Verizon?
Verizon Communications, primarily a regional player, will use MCI's nationwide and global Internet Protocol networks to help it reach out to MCI's business customers--a group among which Verizon has had little success. Enterprise customers could also help New York-based Verizon expand its wireless business, Verizon Wireless, a venture of Verizon Communications and Vodafone Group.

The wireless market is a key market for telecommunications providers. While traditional local and long-distance services have seen a falling off of revenue and subscribers every quarter, wireless plans have been going strong. Right now, much of that growth is among consumers. But as wireless networks add new data services and as company work forces become more mobile, business customers are turning into an important market with the potential for huge growth, analysts said.

"When you talk to CIOs today, they don't want to give their wireless business to one carrier and their data to another," Michael Capellas, CEO of MCI, said during the conference call. "This is a market that will

explode over the next couple of years. Most of the IP decisions will be made over the next few years. When you add wireless, you create the ultimate enterprise bundle."

Like the SBC-AT&T merger announced two weeks ago, the Verizon-MCI deal is about cutting costs. Verizon expects to save $1 billion in the third year after this acquisition is complete, Doreen Tobin, the company's chief financial officer, said during the conference call.

Tobin said Verizon will save money by eliminating most of the cost associated with getting a long-distance provider to carry Verizon's local

This is a market that will explode over the next couple of years.
--Michael Capellas, CEO, MCI
traffic outside of Verizon's own region. It will also save at least $150 million annually on its ongoing plan to build its own long-distance network. The company will also save by consolidating its operational resources, reducing its internal information technology systems and data centers and reducing head count. Tobin said she expects the companies to cut about 7,000 employees in the restructuring.

"We see some big opportunities in eliminating duplicate network resources," she said. "We (at Verizon) have a strong track record of doing this in our own network."

The competition
Qwest had also put a bid in for MCI--which was known as WorldCom until the company changed its name to distance itself from a huge corporate fraud scandal.

After Verizon's intentions became known last week, Qwest supposedly edged up its offer from $6.3 billion to $7.3 billion, according to published reports. Qwest was viewed as a less appealing acquirer due to its poor growth potential and large debt load.

"It was not only a matter of economics but also a matter of which deal offered the best strategic value going forward," said Rick Black, senior telecommunications analyst with Blaylock & Partners. "Even though Qwest offered more, you have to ask yourself if Verizon will be more competitive in the future."

Some analysts said Qwest may put itself on the auction block. But it could be a hard sell, since Qwest's core value proposition is its local telephone business, which has been declining rapidly and is only built out in 14 sparsely populated Western states. What's more, the carrier is the only Baby Bell that doesn't have its own wireless network. In July 2004, Verizon Wireless announced its intent to buy Qwest's wireless assets for $418 million.

"Qwest saw a need to change its business by adding MCI," said Brad Wilson, an analyst with Legg Mason. "I think they'll continue to look for someone to buy them. But it won't be easy at these prices."

The only other Baby Bell left without a dance partner is BellSouth. After the SBC-AT&T acquisition was announced, analysts speculated that BellSouth might make a play for MCI too. The phone company owns 40 percent of Cingular, while SBC owns the other 60 percent. Analysts have speculated that an SBC-AT&T combined company could put pressure on this relationship, since SBC will now be competing head-to-head with BellSouth in its territory.

BellSouth had tried to acquire AT&T a little more than a year ago, but talks between the two companies broke down when the firms couldn't agree on a price, telecommunications industry sources said. BellSouth may have wanted MCI to compete more directly with SBC. Jeff Battcher, a spokesman for BellSouth, declined to comment on the speculation.

Analysts said now that the two biggest long-distance players are out of the market, BellSouth will likely continue with its existing strategy. Sprint, the No. 3 long-distance player, is probably too expensive for

BellSouth--especially since Sprint is already in the process of merging with Nextel.

One rival played down the notion of an increased threat from an MCI-enhanced Verizon.

"It doesn't change anything for BellSouth," Battcher said. "Our focus is on wireless and broadband, and that doesn't change for us" with the Verizon-MCI merger.

He declined to comment on industry speculation that BellSouth had been interested in buying MCI.

"It's a buyer's market for long-haul networks, so there's no need to own the assets," said BellSouth's Battcher.

While buying MCI saves Verizon the time and money of building its own nationwide network to serve business customers, analysts said MCI's network needs major upgrades and investments.

"MCI has been underinvesting in their network," said Brad Wilson, an analyst with Legg Mason. "Just looking at the numbers, it seems like Verizon is going to have to invest a few billion to get the network up to snuff."

Analysts also pointed out there will be other challenges ahead for the two companies. For example, they'll not only have to link up their networks but also find a way to manage MCI's large pool of roughly 60 different billing systems, Black said.

"MCI has grown through acquisitions over the years, and so they have all these different billing systems," Black said. "They used to have about 220 different billing systems, but now it's down to about 60, which is still large."

Neither Verizon nor MCI has commented on specifics regarding the leadership of the combined company.