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JANUARY 31, 2005
By Steve Rosenbush Is SBC Rushing into Trouble? Its $16 billion deal for AT&T would bolster the Bell's offerings to big enterprises. Analysts, however, say that's not where the best money is
After a weekend of intense negotiatons, telecom giant SBC Communications (SBC ) announced a $16 billion takeover of AT&T (T ). Under terms of the deal, announced early Monday morning, SBC would pay $15 billion in stock, plus a special one-time dividend to AT&T shareholders. SBC chairman and CEO Ed Whitacre will run the combined company, and AT&T CEO David Dorman will be president of the new company, to be based at SBC headquarters in San Antonio, Texas. The fate of the AT&T brand hasn't been decided upon. The deal requires the approval of regulators and shareholders. The new company will have about $71 billion in revenue, making it just about the same size as rival Verizon (VZ ). It also will dominate the market for telecom services to large corporations. VERIZON NEXT? An SBC-AT&T combination could lead to more consolidation in the telecom market. Indeed, speculation has swirled in recent days that SBC rival Verizon would attempt to buy the rebuilding MCI (MCIP ), or long-distance and wireless giant Sprint (FON ), or even make its own bid for AT&T. Verizon shares traded actively last week in anticipation of a Verizon move on Sprint, which has recently agreed to merge with wireless carrier Nextel (NXTL ) in a $35 billion deal. But sources close to Verizon say no move by Verizon is imminent. Verizon hasn't ruled out an acquisition. But it's likely to focus on deals that accelerate its strategy of transforming itself into a broadband and wireless company. And it's unlikely to get pulled into an expensive deal. ROAD-SHOW REPAIRS. Shares of SBC fell for the second day in a row on Friday, Jan. 28, as investors and analysts questioned the merits of its AT&T bid. The stock dropped 31 cents, or 1.3%, to $23.36. It has declined 5% from its close on Jan. 26, before news of the merger talks leaked out. It's not uncommon for the stock price of an acquiring company to fall, because the buyer bears the cost of a deal. Companies can often fix the damage by holding "road shows" with major investors around the world to talk up the long-term benefits of the prospective marriage. But recent history shows that such triage isn't always enough. In 2004, Vodafone's (VOD ) bid to acquire AT&T Wireless and Comcast's (CMCSA )'s play for Disney (DIS ) met with fierce resistance from investors. In the end, both deals fell apart. Reaction to the SBC-AT&T merger talks suggests investors won't stand in the way of the deal. "BELOW-AVERAGE RETURNS." Telecom analysts aren't convinced that SBC ought to rush headlong into the so-called enterprise market, the industry term for telecom services sold to large corporations and government agencies. Those accounts are sizable and prestigious, but that doesn't make them lucrative. "From SBC's perspective, it's not obvious to me why they would want to do this now. While big, the enterprise sector tends to generate below-average returns, because of thin margins and high capital costs," says telecom analyst Daniel Zito of investment company Legg Mason. That's why he thinks a combined AT&T-SBC would command a stock-price multiple of 4.5 times earnings. He expects rivals BellSouth (BLS ) and Verizon to command a multiple of 5 times earnings. One telecom investor agreed with that assessment. "AT&T-SBC is a questionable deal at best," says Michael Mahoney, who runs a technology fund for investment company EGM Capital. "I can understand what they're going after, but I think they're going to get a lot of things they don't want and...end up paying more than it's worth." Mahoney, who owns shares of MCI, says he believe AT&T is worth about half the $15 billion to $16 billion SBC may be poised to pay. SMALLER IS BETTER. The size of the enterprise market is declining by about 10% a year. Prices are continuing to fall, albeit not as fast as they were three or four years ago, when deflation in the market ran as high as 30% a year. It also costs providers like AT&T lots of money to employ sales forces and install the networks that clients need so they can use the outfit's services. As a result, enterprise-market profit margins are about 30%. It's often more profitable to serve smaller businesses like grocery stores and law firms than it is to wheel and deal with multinational corporations. Profit margins on the sale of telecom services to small and midsize businesses are in the 35% to 40% range. For big local-phone companies, consumer services are slightly more profitable than those aimed at big businesses. The enterprise market isn't necessarily a bad business for the Bells. But it might make more sense for them to expand organically. In fact, SBC has had considerable success doing that so far. FROM ONE ERA TO ANOTHER? In recent years, the telecom market has rewarded companies that invest in internal growth. Following a long struggle, Nextel got its act together and won a lucrative merger agreement with Sprint. After years of capital investment, Verizon has the fastest-growing wireless business in the U.S. Now, it's trying to duplicate that success in other parts of its empire by building the most ambitious fiber network, capable of carrying TV and superfast Internet access into customer's homes and offices. Even as word of the SBC-AT&T talks leaked out, Verizon CEO Ivan Seidenberg was telling investors that Verizon planned to boost its capital budget to $14 billion in 2005, from a previously forecasted $13 billion. Seidenberg, who has done his share of deals in the past, seems to believe that the era of the big transformative merger has been eclipsed by a new era of organic growth. However, he also may decide that he doesn't have the luxury of standing still if the SBC-AT&T deal goes through. Still, his organic-growth strategy may be out of step with the rest of the market. M&A activity in telecom, technology, and other sectors is booming after years of quiet. But the biggest businesses aren't necessarily the most profitable, and that's why investors aren't cheering SBC and AT&T along. SBC-AT&T appears to be a done deal, but SBC could emerge as a slower-growth company, with a lower valuation than those of its rivals. Who'll bear the brunt of that slower growth? Keep your eye on the stock price.  Rosenbush is a senior writer for BusinessWeek Online in New York Edited by Beth Belton
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