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MARCH 18, 2005
By Steve Rosenbush Whose Promises Will Win MCI? Debt-laden Qwest vows extravagant cost-cutting, while sober Verizon offers far more modest terms
Last September, executives at Qwest Communications International (Q ) believed they were closing in on a deal to acquire the pioneering telecom company MCI (MCIP ). Qwest CEO Richard Notebaert and MCI CEO Michael Capellas met at a hotel in Nashville, a neutral spot well away from the companies' respective headquarters, Denver and Ashburn, Va. At one point, Capellas exclaimed, "Let's do this deal," because he was convinced that Qwest made the best partner for MCI, according to one person familiar with the talks. MCI changed its attitude just a few weeks later, though. That's around the time that AT&T (T ) and SBC (SBC ) began talking about a deal, which they announced at the end of January. And unknown to Qwest, MCI was also getting inquiries from Verizon (VZ ). Talks between MCI and Qwest resumed in December, and Qwest even had a chance to conduct a day of due diligence, examining MCI's books. But Notebaert received a letter from MCI's board saying directors doubted that Qwest could really achieve all the cost cuts that it had promised to wring from an acquisition of MCI. SIREN OF SYNERGIES. Qwest's ability to cut huge costs at MCI remains the crucial issue as the takeover battle for MCI enters its final stages. Last month, Qwest offered to buy MCI for $24.60 a share, but MCI spurned it by agreeing to sell itself to Verizon for $20.75 a share, on the theory that Verizon was a larger and stronger partner. Qwest tried to break up the deal by boosting the percentage of cash in its offer. The companies traded a new round of blows on Mar. 16, when Qwest made a revised offer of $26 a share. And Verizon CEO Ivan G. Seidenberg released a seven-page letter to MCI board Chairman Nicholas deB. Katzenbach, arguing that Qwest was promising more cost cuts than it could deliver. "Qwest's claims do not pass a common-sense test," Seidenberg wrote. Qwest is promising to reap huge savings, known in deal parlance as synergies, from its acquisition of MCI. It promises to cut from MCI a stunning $14.7 billion over the life of the deal. To put that number in perspective, consider that SBC is promising to slice only $15 billion from its acquisition of AT&T, even though the combination of AT&T and SBC would be nearly three times larger than a combination of MCI and Qwest. And Verizon is saying it'll remove just $7 billion from MCI, despite that the union of MCI and Verizon would be two-and-a-half times larger than the combination of Qwest and MCI. Most of the cost savings would come from job reductions. Qwest says it will cut 15% to 18% of their combined workforce. SBC is promising to cut 6% of the combined workforce, and Verizon pledges to get rid of just 3%. The rest of the operational savings would come from moving MCI customers to Qwest's network, which is more modern. EMPTY BRAVADO? Qwest maintains that it will deliver more profit growth, too. The Denver company says it will boost earnings before interest, taxes, depreciation, and amortization by $2.5 billion a year. SBC promises post-deal EBITDA growth of $2 billion a year. And Verizon promises just $1 billion a year. Qwest says its deal would be accretive to shareholders after the first year, while Verizon says it will have to invest $3 billion in MCI's network and wait for three years before shareholders see the benefits of its MCI acquisition. Qwest's claims sound especially bold, considering its status as the weakest of the Bells. It carries debt of $17.3 billion, "more than twice the value of the company's stock," Seidenberg noted with apparent relish in his letter to Katzenbach. It has no wireless network of its own, and its local networks cover just 12% of the U.S. SBC and Verizon, on the other hand, each blanket one-third of the country. Qwest not only is smaller but also generates less cash, and its revenue growth is negative. In fact, Seidenberg may even walk away from the bidding. He believes that "fast money" investors at MCI are using Qwest to squeeze more money out of Verizon. He doesn't like being in that position and has suggested that Verizon could walk away for now and come back later to buy a combined MCI and Qwest out of bankruptcy. JUST A SMOKESCREEN? Is he just bluffing? Maybe not. Seidenberg abandoned the bidding war for wireless carrier AirTouch in the 1990s, allowing Vodafone (VOD ) to win the prize. Now, Verizon controls Verizon Wireless, a partnership that includes Vodafone's AirTouch assets. But people close to Qwest say Verizon's aggressive stance is just a smokescreen. It's in Verizon's interest to act tough in public, to keep the bidding for MCI from accelerating too fast. Qwest executives say they're dead serious about their promises to extract huge savings from MCI. And they scoff at the notion that the company is headed toward insolvency. If Qwest didn't go into bankruptcy several years ago, when its cash position was more precarious and the economy was weaker, it's unlikely to head there now, one Qwest executive says. Qwest's savings are potentially larger because it has more in common with MCI. They both operate nationwide long-distance networks, while SBC and Verizon focus on local phone and wireless phone service. That means Qwest can cut a big swath of overlapping salespeople and technicians. "You would expect synergies in horizontal mergers, where you have two overlapping networks, to significantly exceed the synergies in other kinds of transactions," says one person familiar with the situation. He notes other horizontal mergers, in which one company buys another in a similar line of business, have produced enormous synergies in the past. For example, cellular carrier Cingular's acquisition of AT&T Wireless last year quickly produced huge savings. ANTE UP. One executive close to Qwest acknowledges that the company can't simply flick a switch and close down MCI. It will take some time to get MCI customers to transfer to the Qwest network. But Qwest says most of MCI's customers have two-year contracts, which means a good number of them will be in play after the first year. And faced with an opportunity to lower their costs with a modern, more affordable network, many of them will make the move, even if it means buying new equipment at the outset. MCI says it will give the new Qwest offer a thorough review and reply by Mar. 28. One more round of bids is likely, according to CIBC telecom analyst Tim Horan. He believes Qwest will eventually raise its bid to about $28 a share, the upper limit of what it can afford. Then he expects Verizon to make one of two moves: raise its bid to $25 a share or walk away. Verizon would have a chance of winning the bidding war with a lower bid because it's stronger, he argues. Qwest had better make sure that its cost cuts are realistic because there's a real chance it just might win this fight. And once it owns MCI, it'll need all of the promised synergies to make the deal work.  Rosenbush is a senior writer for BusinessWeek Online in New York
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