View From a Height

Qwest & MCI & Verizon & Bell South

"This is MCI. We're out in merger talks right now, but if you'd please leave your name and phone number, we'll get back to you. Or you can read about it in the paper. < BEEP >"

< teenaged pimple-faced boy voice >
"Uh, hi? MCI? This is Qwest. Are you there? If you're there, could you pick up? Please? It's really important... Uh, thanks."
< /teenaged pimple-faced boy voice >

And so it goes. Look, there's a reason Qwest finds itself listening to the 101 Strings Play the Beatles every time the call about the merger. MCI shareholders believe they're entitled to a premium, even a small one, for the company. After all, they've got this great network, don't they?

Here's the problem: Qwest isn't interested in the network, they want the cash. Qwest has its own state-of-the-art fiber optic network that's sitting there like a desert highway in a car commercial. But they don't have the money to operate it, or do much else. Remember, Qwest owes more than it's worth.

Qwest wants MCI's cash, and they figure that if they pay MCI $6.3 Billion in stock for $5.5 Billion in cash and a rolodex from heaven, that's more than fair. In effect, Qwest is trying to sell a minority share itself to MCI for financing. They'll move MCI's customers from MCI's Route 66 onto Qwest's I-40. After all, Qwest also bought out US West for a huge premium, and then they had to write down the value of that network, plus eliminate about $40 billion in goodwill. They're determined not to make that mistake again.

There are still lots of reasons why this might go through, and other reasons why it might not. Verizon might or might not get into the game, and MCI might be looking at the best offer it's going to get. And MCI also might decide that Verizon stock will be worth more (read: something) than Qwest stock a couple of years down the line. MCI might look at those pending Qwest shareholder lawsuits and get the willies. Also, it turns out that as part of a fraud settlement, MCI proimised the state of Oklahoma that it would put 1600 new jobs in the state over the next 10 years. Who knows what else MCI had to promise various state attorneys general?

What's interesting here in the consolidation is that it's virtually entirely a result of lousy regulation made worse by the FCC. (If Michael Powell is at fault, it's only because he lost the battle; I seem to recall he was on the right side.) The 1996 telecom law was supposed to give Baby Bells and long-distance carriers a chance to adjust, forcing them to sell their network bandwidth at a discount to each other for a while. Networks that each had paid to build. So the law privatized the costs and socialized the benefits. Nifty idea, huh?

Last year, the FCC reworked the regulations. At the time, it looked like they might get rid of all the restrictions, and just let the companies go at it. Instead, they lifted half the rules - they let the Baby Bells charge market rates, but made the long-distance guys keep selling their bandwidth at a discount.

The result, as we now see, is that the long-distance guys have no cash flow, and figure they'd better get out while they still have something worth selling. The bidders are all Baby Bells (SBC, Qwest, presumptively Verizon; Bell South is sitting this one out, but you'll notice they're the ones with the option here), and the sellers are all long-distance carriers (AT&T, MCI).

These last few years should make case studies in Harvard's business and government schools.

This isn't entirely bad - cable companies are getting into the business even as the old giants bow out, and with the exception of Qwest-MCI, the buyers seem to have a long-term strategy in mind. And nobody made Qwest hire a guy (Nacchio, not Notebaert) who didn't really care what business he was in. But people who are complaining about less competition and more consolidation need to think next time before arbitrarity deciding to transfer wealth from one company to another.