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Amid SBC, AT&T Talk, Watch MCI
Friday January 28, 8:23 am ET
By Richard Rhodes, RealMoney.com Contributor
Thursday's reports of SBC Communications (NYSE:SBC - News) taking out AT&T (NYSE:T - News) brings telecom consolidation back into focus. And although the question of why SBC chose to go after AT&T is fodder for plenty of discussion, the more compelling discussion centers on MCI Communications' (NasdaqNM:MCIP - News) acquisition prospects.
I simply believe AT&T is being overvalued vs. my old friend/foe MCI, particularly in terms of their business customers as well as their network infrastructure. Although several of AT&T's financial ratios are a bit better, I don't believe they will be offset by the total amount of debt AT&T continues to carry.
Why SBC Chairman Whitacre is going after AT&T is a very good question that I don't believe anyone can answer at this point. And why aren't they going after MCI? In choosing not to do so, it will force either BellSouth (NYSE:BLS - News) or Verizon (NYSE:VZ - News) to make a move on MCI.
I think Verizon is the more likely choice given that BellSouth is a "bride in waiting" for a merger with SBC at another point down the road because BellSouth will become largely sidelined if SBC does take out AT&T, and the Sprint/Nextel merger is completed. Possibly, Whitacre's legacy will be the reconstitution of a majority of old Ma Bell. I certainly don't know, and to speculate is pure folly, but his tenure has been one of large acquisitions, and adding AT&T and BellSouth back into the fold would accomplish that.
Move to MCI
I consider MCI the main gem of the entire telecom consolidation process. I know the company is a pariah of sorts, given its accounting scandals, but the fact of the matter is that new management has cleaned up the company in terms of the balance sheet and reconstituting its network assets. MCI has a "gold-plated" network -- top notch and in the all the right places.
Plus, it retained a majority of its business customer base after the implosion. When something gets as dirty as this company did, a good scrubbing does wonders for it, and it has here. Right now it is quite simply the cleanest telecom company around.
I am a buyer of MCI here; and I believe it makes sense for the following reasons:
* Lazard and J.P. Morgan Chase are MCI's advisors: They are aggressively seeking to maximize shareholder value, either by selling off certain parts of the company or selling the entire enterprise. The potential AT&T acquisition puts it into play and increases its relative value based on engrained business customers and network assets.
* Old WorldCom bond holders are "anxious" to exit: In the aftermath of the bankruptcy, old WorldCom bondholders received new debt and equity for their old paper. Rest assured they have Lazard and JPMorgan on their speed dial. They are anxious to increase their return, as well as to exit their positions as soon as possible.
* MCI generates "free cash flow": Although revenue for the third quarter was down 3.1% on a sequential basis, it improved EBDIT to $621 million from $610 million. This was because of cost containment as well as prioritizing capital spending outlays.
* Balance sheet cash/equivalents, $5.6 billion: This total is in excess of its total debt, but the company has an annual dividend commitment of $500 million. This certainly makes the deal more attractive given the large cash component coupled with free cash flow.
* MCI acquisition price would be $6 billion to $7 billion: Comparatively speaking, if SBC is going to take out AT&T near $16 billion, then one would be "getting a deal" with MCI. AT&T's revenue is $25 billion; MCI's total is $20 billion. Do the math -- synergies can be had to offset MCI's lower EBITDA-to-sales ratios as well as cost-to-sales ratios.
* Verizon needs a long-haul and IP networks: Plus, Verizon gains MCI's corporate customers and can stem the tide of business customers leaving it for MCI. In effect, Verizon pays for the customers and gets the network for free.
To sum up, MCI shares are a buy here because the company will be the last horse standing that has a worldwide network footprint. The company will be acquired -- the question is by whom and when. At the pace of current consolidation I can only think it will be sooner rather than later. At a relatively cheap price tag of $6 billion to $7 billion, the acquirer will gain $20 billion in retail and business revenue, and then be able to effect cost synergies elsewhere. So any acquirer would essentially be acquiring their network assets free of charge.
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