Verizon's Spin-off Offensive

While rival AT&T focuses on mergers, Verizon's latest slim-down move sheds some New England assets in a deal with FairPoint Communications

by Spencer E. Ante

In telecommunications, bigger is not necessarily better. Or so goes the thinking at Verizon Communications (VZ).

The latest sign of Verizon's penchant for slimming down—call it the Jenny Craig approach—came on Jan. 16, when the New York phone giant announced a deal to spin off operations in three New England states and merge them with FairPoint Communications (FRP), a Charlotte (N.C.)-based telecommunications provider.

Verizon is shedding about 1.5 million access lines in largely rural areas in Maine, New Hampshire and Vermont in exchange for $1 billion in FairPoint stock and a 60% stake in the new company. The transaction also lets Verizon free itself of $1.7 billion of newly issued debt, which will be assumed by the newly formed company. "It's clear that Verizon is interested in focusing and picking its customer base," says Scott Cleland, president of research firm Precursor LLC.

Verizon's strategy stands in contrast to the one being followed by AT&T (T), which is bulking up all the time. Call it the George Foreman approach. Verizon was created in 2000 by the merger of GTE and Bell Atlantic, and for a time, it was the largest local telecommunications company in the U.S. It was forced to cede that title at the end of last year, as AT&T closed its $86 billion acquisition of BellSouth. "AT&T has preferred to go for scale," says Cleland.

Indeed, the BellSouth merger was only the latest in a long string of megadeals for AT&T. Since becoming chief executive of the former Southwestern Bell in 1990, Edward Whitacre Jr. has virtually recreated the old Ma Bell. He has pulled off 13 deals with a combined price tag of $285 billion, including assumed debt. Thanks to those mergers, AT&T now is the king of U.S. telecom. The enlarged AT&T and BellSouth will claim about 60 million access lines, while Verizon owns about 40 million access lines.

So far, Verizon executives don't seem too concerned that they have been overtaken by AT&T. Instead of growing through acquisitions, Verizon Chief Executive Ivan Seidenberg remains focused on generating organic growth through transforming the phone company into a broadband behemoth. Verizon plans to spend $18 billion in six years to connect 18 million homes by 2010 with extra-fast fiber-optic lines. The network upgrade will let Verizon offer phone, Internet, wireless communications, and TV service all through one pipe, on one bill. "We are aggressively trying to drive broadband into our wireline business," says Virginia Ruesterholz, president of Verizon Telecom. "Our strategy is about organic growth and we feel that is the way to do it." The FairPoint deal, she adds, will allow Verizon "to focus a little better on that strategy."

Investor Reaction

So far, investors prefer the way AT&T is adding bulk like George Foreman. Last year, AT&T's stock jumped 31%, compared with a 24% gain for shares in Verizon. Investors are betting AT&T will be able to generate earnings growth through merger-driven cost savings. By contrast, investors are less sure Verizon will be able to produce a return on its massive fiber-to-the-home investment. "Verizon is more focused for the long term," says Cleland. "AT&T is more optimized for 2007 performance. There is a more immediate return." Indeed, in 2007, analysts expect Verizon to earn $6.6 billion on $90 billion in revenues, compared with $10 billion of net income on $110 billion in sales for AT&T.

Verizon is confident that focusing on broadband in major metropolitan areas is the right approach. Rural areas tend to be less wealthy and are more expensive to connect with fiber optics. "Subscribers in the rural areas are less likely to buy a bundle of goods," says Jeffrey Williams, the former head of Morgan Stanley's telecommunications group, who now runs his own consulting firm, Jeffrey Williams & Co.