Friday, May 06, 2005

“The Highest Priced Phone May Not Be the Best”

The goal of every company is to maximize shareholder value. During the Internet boom, many companies were only looking for the quick payoffs. This short-term thinking caused many companies to be overvalued and over levered. So when the internet bubble burst, companies were not structured to sustain the downturn. As the economy starts to recover, companies are getting back to business basics, by maximizing shareholder value over the long-term. Recently, MCI’s Board maintained this core value.

Since early February 2005, Verizon and Qwest have been in a bidding war for MCI, the nation’s second-largest long-distance telephone carrier, after AT&T Corp. Qwest and Verizon each view MCI’s business as a critical piece to compete against the expected merger of SBC and AT&T. The MCI bidding first started with Qwest attempting a takeover bid for MCI. By February 10th, Verizon had entered the market for MCI. Within a week MCI’s board approved Verizon’s $20.35 per share offer, shunning Qwest’s higher bid in favor of what it believes are better business prospects with Verizon. This did not stop Qwest from trying to win over MCI shareholders because of its higher bid. Over the next three months, at least three new bids from Verizon and Qwest were reviewed by MCI board members.

On May 2, 2005, MCI’s Board accepted an enhanced offer from Verizon Communications Inc. MCI’s board has agreed to Verizon’s lower priced-offer mainly based on the current capital structure of Qwest. Qwest, based in Denver, is the fourth-largest local telephone company in the U.S., with a stock-market value of about $7 billion. It also has roughly $17.3 billion in debt, and the deal for MCI, of Ashburn, VA, is viewed as crucial to Qwest’s prospects. Qwest has been suffering local access line losses at nearly four per cent per year for the past several years. Qwest’s debt rating is similar to MCI, B2, which generally reflects operating struggles due to the intense competitive nature of the telecommunications industry. Moody’s believed a merger of MCI and Qwest would only work if redundant network costs were eliminated while also stabilizing top line revenue declines in both companies’ core businesses. The potential deal of Qwest/MCI would also create a levered company that would not be able to handle a downturn in the economy. With too many what concerns, MCI Board decided the Verizon deal would maximize shareholder value over the long-term.

The merger with Verizon will capitalize on the complementary strengths of the two companies and will create one of the world’s leading provider’s of global communication services. With more than $71 billion in annual revenues and a market value of about $99BN, Verizon Communications Inc. (NYSE:VZ) is one of the world's leading providers of communications services. Verizon has a diverse work force of 214,000 in four business units: Domestic Telecom provides customers with wire line and other telecommunications services, including broadband. Verizon Wireless owns and operates the nation's most reliable wireless network, serving 45.5 million voice and data customers across the United States. Information Services operates directory publishing businesses and provides electronic commerce services. International includes wire line and wireless operations and investments, primarily in the Americas and Europe. MCI would be its fifth business unit focusing in the long distance market.

We believe that MCI’s Board made the right decision by accepting the Verizon deal. As companies determine who is a good partner, all aspects of the company and the business must be evaluated. Synergies are a major factor in determining if a company is a good fit. The nature of the telecommunications industry requires that effective competitors have financial strength and a full array of offerings. The financial strength was one of many factors in why MCI decided to choose Verizon. Another factor MCI was the reaction by current customers backing the deal with Verizon. The high leverage position of Qwest was a deterrent for MCI due to its uncertainty of sustainability in a downturn of the economy.

The one factor that is over looked in the deal is the consumer. As the telecommunications industry continues to consolidate, competition may lessen which could lead to price increases. The government could try to regulate this increased competition, but new government regulation started the furious rush of mergers. The government increased operating costs for long distance carriers, which is why many long distance companies are trying to merge to create synergies going forward.

Overall, MCI’s board has proven its worth by addressing all issues and deciding what they think is sustainable shareholder value and growth over the long-term. There are many issues that can affect the outcome, but at least the MCI’s board has started in the right direction, despite taking a discount now.

David Smith, Troy Stalter, Greg Watson


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