THE MATH BEHIND THIS $34.5 BILLION DEAL
Nobody has ever accused WorldCom Chairman Bernard J. Ebbers of getting lost in a balance sheet. So how come he's offered to pay $11 billion more for MCI Communications Corp. than British Telecommunications PLC is willing to cough up? The answer is twofold: cost savings and a rich multiple on WorldCom's stock.
Ebbers, who has made a career out of squeezing money out of mergers, sees a gold mine in an MCI deal. The cost savings would come from three areas: combining long-distance and local businesses, melding costly administrative functions, and paring back MCI's ambitious plans for a local phone network.
The investment in a local network was perhaps the sharpest thorn plaguing the BT-MCI deal. BT cut its offer for MCI in August after the U.S. company estimated local phone-biz losses this year at $800 million, with even bigger losses possible in 1998. The BT deal was premised on a strong local presence for MCI, but WorldCom is already strong in local. ''The synergies achievable as result of a combination with WorldCom are not achievable with BT,'' Ebbers says.
In addition, BT, located on the other side of the Atlantic, has few operations that overlap with MCI. BT figured it could save only $2.5 billion over five years by linking up. Overlapping systems and operations would be far more significant at WorldCom/MCI. Combine savings there with lower investments in local services, and Ebbers estimates that the new company could save at least $2.1 billion in the first full year alone. The savings would total some $15 billion over five years.
That easily covers the $11 billion premium in the stock portion of the deal, but there's more. It's as though one bidder in the auction was using dollars while the other was stuck with rubles. WorldCom's high valuation on Wall Street means its stock trades at some 90 times expected earnings per share. BT's price-earnings ratio is just 14, about in line with the other telecom giants. Thus, Ebbers was able to offer $30 billion of stock to MCI shareholders and use a smaller proportion of his shares to make the purchase. Besides getting more bang for his shares, Ebbers would have to spread earnings of the combined company over fewer shares after the merger. Thus, WorldCom estimates that just combining the companies would mean an earnings increase of 20% a share.
The BT deal was already slightly dilutive, which meant earnings per share would have suffered, and BT's bid was about as high as it could go. ''When you have a high-value stock like WorldCom,'' says Sanford C. Bernstein analyst Tod A. Jacobs, ''It provides you with a phenomenally strong currency.''
If the market begins to doubt the payoff of a deal with MCI, WorldCom stock will slide, and the deal becomes less attractive to MCI shareholders. One unknown: whether MCI's long-distance problems will persist. ''If MCI's business continues to deteriorate,'' warns Gary M. Stibel, principal of New England Consulting Group, ''those cost savings could be eaten up by revenue losses.'' Should that happen, Ebbers may find Wall Street is quick to cut off the cheap funding that put WorldCom on the map.
By Amy Barrett and Catherine Yang
Updated Oct. 2, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.