AT&T's Campaign for Compromise

Hoping to win over reluctant regulators, the telecom giant is willing to make concessions on its planned BellSouth takeover

By Steve Rosenbush

Discussions have reached a critical stage between merger partners AT&T and BellSouth and the Democrats in Washington who have held up approval of the companies' $79.3 billion deal.

AT&T (T) and BellSouth (BLS) are willing to make concessions in a bid to assuage government concerns over the elimination of a potential competitor in the lucrative market for business telecommunications services. Analysts say there's a good chance the companies will know by the end of the week whether they can reach a compromise. Lawmakers such as Representative John Dingell (D-Mich.) have become more vocal about their reservations since the Democrats took control of the House and Senate in the Nov. 7 general election (see BusinessWeek.com, 10/20/06, "The Politics of Change").

If a compromise is reached, the deal could be approved at the Dec. 20 meeting of the Federal Communications Commission or at an FCC meeting in January. "We will know more this week," says former FCC official Blair Levin, now a regulatory analyst with researcher Stifel Nicolaus. "The odds still favor the deal being done in December, although there's a decent chance that it slips into January." The two Democratic FCC commissioners oppose the planned transaction, while two of the three Republican commissioners back it. The fifth commissioner has recused himself from deliberations, citing past employment with companies that compete with AT&T (see BusinessWeek.com, 10/13/06, "AT&T: Waiting for the FCC's Call").

Determined to Merge

AT&T says that closing the deal remains a top priority. "We are completely committed to this merger, which will create substantial benefits for our customers.…Discussions are ongoing and we remain hopeful that the merger will be approved by the end of the year," AT&T spokesman Selim Bingol says. The deal remains vitally important for AT&T, which is trying to consolidate its control over the Cingular wireless network (see BusinessWeek.com, 3/20/06, "Lord of the Rings"). Cingular is owned by AT&T and BellSouth. Cingular was formed before SBC Communications acquired AT&T and took the AT&T name. The AT&T long-distance business competes with BellSouth for lucrative corporate customers in the South.

In a signal that shareholders buy the rationale behind the takeover, the deal could be more expensive than originally envisioned, at least by one measure. Since Mar. 3, the last day of trading before the deal was announced, the market value of suitor AT&T has increased by 20%, to $125 billion. The value of BellSouth has increased 39% to $77.8 billion. The original announced value of the deal was $67 billion.

AT&T, which is offering to exchange 1.325 of its shares for every share of BellSouth, must now pay $79.3 billion for the acquisition. However, shares of both companies have increased about 30% since the beginning of the year, when speculation over a deal began to appear in news reports.

The McDowell Factor

If AT&T and BellSouth can't reach a compromise with Democrats on the FCC, it's possible to break the current 2-2 deadlock by calling in Commissioner Robert McDowell. But McDowell, who is expected to vote to approve the deal at the expense of the competitive telecom industry he once represented, still could be a factor in the deliberations. If a deadlock persists, the FCC's general counsel could advise that the public importance of ending the deadlock outweighs any potential conflict of interest in this particular case, and that McDowell should be able to cast a vote on the deal.

While it might appear controversial to bring McDowell into play, Republican FCC Chairman Kevin Martin may have the political clout to do it. He was recently reconfirmed by Congress, boosting his job security and his power.

The Democrats' leverage has been boosted, too, by Democratic victories in Congress—and the fact that the Justice Dept. gave its assent without reservation. "It's not that [the Democrats] won't favor the deal," says telecom analyst Colby Synesael of investment bank Merriman Curhan Ford. "They won't favor it without any agreements being made."

Merger Consequences

Levin and Synesael say three issues are at stake. There's the question of whether AT&T will be allowed to charge big Internet companies such as Google (GOOG) a premium for handing large amounts of traffic, including video files. Democrats and other Internet advocates believe the issue, known as net neutrality, is critical to the future development of the Web. They say all Internet users should be charged on an equal basis, regardless of their size.

Telecom companies such as AT&T say they should be allowed to charge for different tiers of service, just the way the postal system and package delivery companies do. Under a possible compromise, AT&T might agree to freeze its rates for a specific period of time, people familiar with the matter say.

Other issues include the rates that AT&T charges rivals to connect to its networks, and whether it should be forced to sell off some of its wireless spectrum. While some Democrats would like to force AT&T to give up some of its wireless spectrum and to agree to resolve price disputes with its rivals through third-party arbitration, a Republican majority isn't expected to make such demands.

Despite their increased power, the Democrats can't undo the fact that Republicans appointed the current members of the FCC. And for that reason, they simply won't have enough votes to block the AT&T deal or impose particularly demanding conditions.

Rosenbush is a senior writer for BusinessWeek.com in New York.