Bear Stearns' Deatherage on USW / QWST / GBLX (from last week):
[email me for complete report with extensive table details]
Deal Math for U S WEST
n Several outcomes are possible in the bidding for U S WEST (USW, $58) and Frontier
(FRO, $58). In our view, the prospect that either of the two three-way transactions is
ever consummated as proposed is less likely than some iteration or combination of these
deals, or an entirely different deal. Besides the possibility that some or all of the
companies may negotiate a solution, new parties could join the contest, either alone or in
concert with the current players.
n Despite the uncertainty created by the merger accord with Global Crossing (GBLX, $50)
and the acquisition offer by Qwest (QWST, $38), the risk-reward in USW is positive.
The company is in play and the stock price is below the levels of early 1999. Although
U S WEST's region has less strategic significance than those of the other original Bell
holding companies, the company's large customer base has great value. As the industry
becomes more competitive, scale and scope will grow in importance. U S WEST brings
both to an acquirer.
n The biggest variables in evaluating the financial consideration to USW holders in the
current transactions are the prices of GBLX and QWST. Even before the prospects of
these controversial business combinations, these stocks were volatile. In addition, due to
the thin public float, the trading price of GBLX may not reflect the “real” market
valuation for the company. Furthermore, in our opinion, the combination of Global
Crossing and U S WEST is not as strong a competitive entity as Qwest and U S WEST.
n This report exhibits the financial consideration to U S WEST and Frontier stockholders in
the alternative transactions. Various price points are considered. In the case of the
Global Crossing agreement, the effect of the election rights for “L” and “G” shares is also
examined. As mentioned, the end result of the bidding may turn out quite different than
the scenarios presented here, but the prevailing terms are the benchmarks for future
offers. In fact, the weakness in both deals is the unpredictability in the final value. At
this point, the firmness of an offer is more important than the size.
On May 17, U S WEST and Global Crossing agreed to form a new company (also
called Global Crossing) and establish two tracking stocks, Class G (for growth
investors) and Class L (for income-oriented investors). Class G shares will not pay a
cash dividend; Class L shares will pay an “attractive” dividend. The transaction,
which is expected to be tax free to shareholders of both companies, could close by
mid 2000. The managements expect to use purchase accounting.
The terms of the deals are analyzed more fully below. As a summary:
ΠFrontier: Global Crossing has modified its merger agreement with Frontier.
Each FRO share will be exchanged for $63 worth of GBLX stock if $34.56 <
GBLX < $56.78. If GBLX > $56.78, each FRO share will be exchanged for
1.1095 GBLX shares. If GBLX < $34.56, each FRO share will be exchanged for
1.8229 GBLX. If the Frontier merger does not close by December 31, 1999, the
$63 per share value increases by 7% per annum compounded daily until closing
(unless GBLX > $56.78).
ΠGlobal Crossing: Each GBLX share will be exchanged for 1.0 election right for
Class G and/or Class L tracking stock. Each Global Crossing shareholder may
elect to receive differing percentages of the two tracking stocks, subject to
proration if either is oversubscribed.
ΠU S WEST: Each USW share will be exchanged for 1.21-1.46 election rights
(discussed below) for Class G and/or Class L tracking stock. Each U S WEST
shareholder may elect to receive differing percentages of the two tracking stocks,
subject to proration if either is oversubscribed.
ΠTender for GBLX shares: As part of the merger agreement, U S WEST
undertook a cash tender offer for 39.3M GBLX shares at a price of $62.75 per
share. As a result of voluntary restrictions by insiders, all other GBLX
shareholders sold approximately 18% of their holdings in the tender.
ΠDividends: U S WEST will also declare a special cash dividend of $0.215 per
share payable to USW holders in each quarter prior to closing. This will
temporarily increase U S WEST's quarterly dividend payment to $0.75 per share.
U S WEST intends to declare a onetime special cash dividend of up to $1.00 per
share payable to U S WEST shareholders immediately prior to closing.
In our view, the strategic rationale for the merger of U S WEST, Frontier and
Global Crossing is faulty. In addition, in the past U S WEST emphasized the in-region
opportunity. Thus, the proposed business combination also represents a sharp
change in the stated corporate strategy.
The “new” Global Crossing will not have the critical mass of the other national
companies produced by ongoing industry consolidation. This could handicap the
competitive position of U S WEST inside and outside of its 14-state territory. The transaction
is actually a recapitalization (regrouping of operations) of the two
companies rather than a merger in the industrial sense.
The new Class G shares will track the economic performance of Global Crossing's
global fiber optic network; U S WEST's !NTERPRISE data networking business,
frame relay and ATM network, PCS, and Internet Yellow Pages operations;
Frontier's long distance, Internet web hosting and data center, and CLEC business;
and a new data LEC initiative. The company will have approximately $6 billion in
revenue.
The new Class L shares will track the economic performance of U S WEST's and
Frontier's local telephone operations (17.3 million access lines in total) and printed
Yellow Pages businesses. The company will provide local service in 25 states and
have approximately $13.5 billion in revenue, including $1.2B in vertical services
sales.
The tables in this report provide example outcomes to U S WEST (USW, $58)
investors under the terms of the May merger agreement with Global Crossing
(GBLX, $49¾). Several variables determine the amount and type of consideration
that USW holders will receive.
Table 1, page 6, traces the construction of the stock market capitalization of the new
company (Global Crossing + Frontier + U S WEST) under five GBLX price points:
$60 (above the Frontier collar), $56.78 (top end of collar), $45.67 (middle of collar),
$34.56 (bottom of collar) and $30 (below collar).
The most important factor in fixing consideration in the deal is the trading price of
GBLX. Since U S WEST investors will own one-half of the combined enterprise,
USW holders effectively will share in any upward or downward move in the price of
GBLX.
The trading price for GBLX will also impact the share count (both “L” and “G”) of
the new company. The Global Crossing-Frontier merger accord guarantees FRO
holders $63 of GBLX if GBLX trades in a $56.75-$34.56 collar. As such, the
number of GBLX shares (and, therefore, election rights in the new company) issued
to FRO holders could vary between 201M and 331M (1.0 GBLX share = 1.0
election right). See Table 1, Sections A and B, page 4.
The number of GBLX shares issued in the Frontier merger also impacts the number
of election rights provided to U S WEST shareholders. USW holders are guaranteed
an equal number of elections in the new company as the GBLX/FRO holders. As a
result, the number of elections supplied to USW holders could vary between 620M
and 750M (1.0 USW share = 1.21-1.46 election rights). See Table 1, Section B,
page 4.
On June 13, Qwest Communications International made separate offers to acquire
U S WEST and Frontier. Qwest expects the U S WEST and stock portion of the
Frontier transactions to be tax free. Qwest anticipates using purchase accounting in
both deals. Neither proposal is conditioned upon acceptance of the other proposal.
U S WEST: Shareholders receive 1.738 QWST shares for each USW share. If
Frontier agrees to a business combination with Qwest, shareholders receive 1.783
QWST shares for each USW share. In addition, Qwest will assume $10 billion of
U S WEST debt (before the effect of the Global Crossing tender offer).
Frontier: Shareholders receive 1.181 QWST shares plus $20 in cash for each FRO
share. If U S WEST agrees to a business combination with Qwest, shareholders
receive 1.226 QWST shares plus $20 in cash for each FRO share. In addition, Qwest
will assume $1.4 billion of Frontier debt.
In our opinion, the Qwest proposal to purchase U S WEST is preferable to that of
Global Crossing in all respects. The strategic rationale for the transaction and the
structure/organization of the new entity are superior to those in the Global Crossing
agreement.
The three-way combination of Qwest, Frontier, and U S WEST has far better
prospects. In contrast to Global Crossing, Qwest has significant operating revenue,
conducts business mostly in the U.S., and has a retail strategy. As a consequence, the
merged company can derive significant economies of scale and scope that are lacking
in the Global Crossing transaction.
Qwest could become the fifth large-scale player. Considering the alliance between
Qwest and BellSouth, the industrial size of the “new” Qwest is in the same class of
national competitors as AT&T, MCI WorldCom, SBC/Ameritech, and Bell
Atlantic/GTE. In addition, the simple merger of the three companies is a preferable
corporate structure to the target stock plan in the Global Crossing agreement.
Under the Qwest offer, USW holders will likely lose most or all dividends
(regular payout of $2.14 per share annually). In light of Qwest's growth strategy, the
lack of dividends is logical (just as the dividend increase is illogical in the case of the
Global Crossing deal). Qwest can reinvest more than $1 billion in dividend-related
after-tax cash flows. U S WEST shareholders are compensated by a higher
acquisition price, if not future capital appreciation in new QWST shares.
Table 3, page 11, traces the construction of the stock market capitalization of the
“new” Qwest. Different combinations (Qwest + U S WEST + Frontier, Qwest + U S
WEST, and Qwest + Frontier) are considered under five QWST price points: $45,
$40, $35, $30, and $25. The table compares potential returns under each scenario. |
