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How Mci Got A Bad Connection


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HOW MCI GOT A BAD CONNECTION

In January, when Nextel Communications launched a souped-up digital dispatch service in Los Angeles, Thomas O'Mara was one of the first customers to sign up. The owner of O'Mara Plumbing Co. was lured by the promise of superior sound quality and an expanded calling area for his 10-truck fleet. Nextel even threw in steeply discounted mobile-phone service.

Eight months later, O'Mara has a verdict on this latest entry in the wireless sweepstakes: The dispatch service is terrific. The phones? Well, O'Mara got what he paid for. Calls, he gripes, "sound like you're underwater."

If you want to know why MCI Communications Corp. on Aug. 29 pulled out of a deal to pay $1.36 billion for 17% of Nextel, look no further. In February, it thought it had found a clever, state-of-the-art way to compete with cellular-phone companies: Nextel planned to use existing dispatch licenses to build a national digital-phone service rivaling cellular's quality. Instead, MCI bought a lot of static. "The quality just wasn't there," says Barry Goodstadt of EDS Management Consulting Services.

WORMY BITE. The deal underscores the risks that accompany the telecommunications industry's headlong plunge into the future. Under intense competitive pressures, say company insiders and former executives, MCI officials failed to do their homework on the new technology. "Sometimes when you bite the apple first, all you get is worms," notes P. William Bane of Mercer Management Consulting Inc.

It's easy to see why Nextel caught MCI's fancy. Archrival AT&T had agreed the summer before to merge with McCaw Cellular Communications Inc. Buying a cellular operation would be hugely expensive. And the other option for entering the wireless business--the Federal Communications Commission's auction of 2,000 separate licenses for personal communications services (PCS)--would have made assembling a national network difficult.

So when Nextel's chairman, supersalesman Morgan E. O'Brien, knocked on MCI's door, Chairman Bert C. Roberts Jr. was receptive. Nextel would give MCI an entree to wireless markets across the nation before PCS could take root. And MCI would provide Nextel with deep pockets to fund expansion and with a brand name to help market its service.

But MCI's top brass made a critical misstep: They didn't clue in technology-savvy subordinates. Those aides winced when they saw the deal. Nextel's system operated with only 10 megahertz of radio-spectrum capacity, far less than the 25 Mhz that cellular companies use. To improve quality, Nextel would have to reduce the number of calls it handled or build a vast network of radio towers. Either option would boost the average cost per call far higher than MCI had initially figured, dramatically altering the value of its deal.

MCI did not carry out engineering studies confirming these fears until after the deal was announced, say executives involved in the negotiations. MCI won't comment. Nextel confirms it had quality problems. But "customer satisfaction has improved dramatically," says James M. Dixon, president of Nextel's Digital Mobile Networks Div.

DISENCHANTMENT. Meanwhile, the FCC was making PCS more attractive. In June, the commission overhauled its auction plans to make it far easier to cobble together the national network that MCI covets. The FCC's moves and a disenchantment with Nextel fueled opposition inside MCI to the linkup, which was supposed to be completed by June 30. One senior wireless executive, Albert Grimes, left in July, disgusted with the deal. As the talks dragged on past the deadline, MCI insisted on improving quality by lowering capacity--and demanded a price break.

Nextel resisted. It needs cash to extend its network, established primarily with equity-based acquisitions. Motorola, which holds a major stake in Nextel and can veto any future Nextel deals, also balked. In early August, Motorola sold its remaining dispatch licenses to Nextel for $1.7 billion in stock. Motorola feared that if MCI dropped its price, the proceeds of its licenses sale would plummet. In fact, Nextel's stock dropped 17%, to 251/4, on MCI's pullout.

The talks go on. But now, MCI has other options. If it wants to line up partners for the FCC auction and use its $1.3 billion for the bidding, it must decide by October, when applications are due at the commission. Such a strategy remains problematic. But in the end, a direct route to market may be safer than a back-door approach: In devising the Nextel deal, MCI may have been too clever for its own good.

REDIALING

MCI

With AT&T-McCaw breathing down its neck, MCI still needs a foothold in wireless. It may bid for radio spectrum at the FCC's December auction or link up with a Baby Bell.

NEXTEL

If the deal doesn't go forward, Nextel will need cash to expand its network.

And the company also could use another big-name partner to help sell its service and to establish brand-name recognition.Mark Lewyn in Washington


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