Big-Time Telecom Carriers: Who's Next?
By Louis Trager and Kimberly Weisul
May 24, 1999 9:38 AM ET
zdnet.com
The dust hasn't settled and the question already arises - who will become the next Global Crossing? Put another way: Which hot, next-generation telecommunications carrier will use a sky-high stock valuation to grab a bigger, established player - as Global Crossing did last week in its brazen combination with U S West - and instantly vault into the industry's top tier?
The answer should appear sooner rather than later. Remember: MCI WorldCom was proclaimed the next AT&T a little more than 18 months ago, but then Qwest Communications International suddenly blossomed and became the season's darling instead.
Analysts said there's every likelihood that the Global Crossing phenomenon will replicate itself, as long as the bull market keeps transforming start-up stock certificates into precious takeover tender.
"CEOs [chief executive officers] of large phone companies used to lie awake at night and worry about each other," industry analyst Jeffrey Kagan said. "Now, they are worried about start-ups that come out of nowhere and change the rules before they can react."
Qwest itself is a likely suspect to become the "next Global Crossing," as is Level 3 Communications. The Denver duo has captured journalists' imaginations, Wall Street's wallets and even customers' business by racing to build out fiber and Internet Protocol (IP) long-haul networks for a dawning era of massive bandwidth.
Beyond Level 3 and Qwest come companies that remain pretty obscure, just as Global Crossing was three months ago. These include Global TeleSystems Group and Teleglobe, which made significant acquisitions last year and aren't shy about expansion ambitions or further purchases, and the lower-key but larger Equant.
There are powerful reasons for the world's would-be Global Crossings to continue stalking the U S Wests. These reasons include little things like customers, revenue and even profits, not to mention sales, provisioning and billing machinery. "What you're seeing is the marriage of networks and customers and cash flows," Legg Mason Wood Walker telecom analyst Daniel Zito said.
The strategic imperative in the industry is combining a U.S. network with local connections and adding global links starting with Europe - all preferably broadband and IP-based. For many players, building substantial pieces of this structure seems far too slow compared with buying them.
The model of upstarts ambushing bigger incumbents will represent but one in a kaleidoscope of continuing mergers and acquisitions. Even America Online, desperate especially for broadband access to customers, and Microsoft, which keeps making cable and communications technology investments and has a hand in nearly everything, have great stock market values and cash hoards; they must be kept in mind as potential acquisitors of telecommunications companies.
First, though, step back and inspect Global Crossing's handiwork.
History lesson
Granted, this wholesaler of intercontinental and transcontinental fiber capacity didn't exactly invent bootstrapping one's way into the telecom elite on the strength of a high stock valuation. WorldCom, founded in 1983, pioneered this technique, capping a nine-year shopping spree with its 1997 takeover of MCI Communications for $40 billion. Last year, Qwest bought the larger LCI International for $11 billion. But Global Crossing popped up even faster with bold, back-to-back stock deals.
Just three months ago, the Bermuda-based company attracted its first real notice by hiring Robert Annunziata as its CEO. Annunziata was a senior business-markets executive from AT&T and veteran of the local competition wars at Teleport Communications Group.
The next day, it seemed - actually, it was three weeks - Global Crossing put itself on everyone's radar screens by agreeing to buy Frontier, a long-distance and local carrier with a dingy financial history but flashy U.S. fiber network, for $11 billion.
Last week, exactly two months later, Global Crossing pulled a trifecta by announcing a $37 billion deal to combine with U S West, a dominant local carrier in 14 Western states and one of just two regional Bells out of the original seven still operating independently.
Global Crossing's management team is headed by former Drexel Burnham Lambert trader Gary Winnick and is loaded with financial acumen. The team launched its vehicle into the industry stratosphere with a fuel mixed from two of the most explosive elements of '90s business life: bandwidth fever in the telecommunications market and Internet mania in a go-go stock market.
The company succeeded in portraying itself as having essentially cornered the market in undersea-cable know-how, analysts said - creating the ironic prospect of a bottleneck in international data communications controlled by a new competitor. Such leverage over booming global communications excited Wall Street so much that by the time its bid emerged for U S West, Global Crossing's market capitalization, not including Frontier, had soared to $24 billion, based on a tripling of its stock price in 1999.
What does U S West offer? For starters, direct connections with customers. True, U S West's home region is the smallest and least dense of any Bell's. But it's also the fastest-growing market - including dynamic metros Denver, Minneapolis, Phoenix, Salt Lake City and Seattle - and U S West has aggressively followed its corporate data customers out of the region.
The data business is considered the most sophisticated of the Bells' businesses. It's not just transport but also the sorts of value-added services, from Web hosting to network-hosted back-office applications for midsized companies, calculated to keep carrier profit margins from vanishing down a commodity-transport sinkhole and to minimize customer turnover. Developing such Internet services and hosted applications has put U S West into closer relationships than other establishment telcos with technology heavyweights such as Hewlett-Packard and Microsoft. Finally, U S West's big data play could make a good fit with Frontier's well-regarded data centers.
Not everyone is persuaded, however. Telecom expert Roger Wery of Renaissance Worldwide, a consulting firm, sees a mismatch between Global Crossing's "stripped-down wholesale operation" and U S West's "complex retail organization with a not-attractive cost structure and revenue base." Global Crossing's share price took a big hit, down about 18 percent through May 19, to $53.38. As the acquisition target, U S West took a smaller but more unusual hit, losing about one-eighth of its value, to $54.88 in early reaction on May 19.
Global Crossing got its payoff while the getting was good. Craig Moffett, a telecom expert at Boston Consulting Group, had so much trouble finding "synergies" that he concluded the whole short saga boiled down to a financial maneuver, trading Global Crossing's good story for U S West's real business.
The deal itself is complex. The combined company plans two classes of tracking shares. The global service provider shares are the exciting stuff: Global Crossing's fiber network; U S West's data group, wireless operations and Internet Yellow Pages; plus Frontier, except its local services business. The local service provider shares get U S West's local exchange, future in-region long-distance, and private line and directory operations. Executives expect the global unit to have annual revenue of $6 billion in 2000 and cash flow of $1.4 billion, while the local service provider should have $13.5 billion in revenue and $6.7 billion in cash flow.
But two things are clear: Global Crossing will receive a cash infusion of $2.4 billion without having to wait months for the merger's regulatory clearances. And the scheme for issuing tracking stocks may be as hard a sell as it is a creative solution to an investor relations nightmare - melding high dividend-low valuation phone operations with data businesses that have little or no profits but huge investor expectations.
Though Global Crossing is the official purchaser, the first step is U S West's buying 9.5 percent of Global Crossing stock - near the maximum allowed under long-distance restrictions, and paralleling other recent Bell long-haul broadband investments, SBC Communications in Williams Communications and BellSouth in Qwest. The idea is to cement the Global Crossing-U S West relationship, deter counteroffers and perhaps compensate Global Crossing shareholders for getting a smaller exchange ratio than U S West holders for the merged outfit's stock.
The investment gives Global Crossing's balance sheet a quick boost, an advance on the $3 billion cash U S West generates annually. "Global Crossing needs the cash for their build-out," said Peter Treadway, senior vice president at Southeast Research.
Global Crossing is wooing U S West shareholders, who will see the cash flow from their plain old telephone service shares finance growth of the riskier data play. They get a special dividend of 21.5 cents per share each quarter until the deal closes, for a quarterly total of 75 cents per share, plus a $1 bonus dividend on closing.
Qwest reportedly considered making its own move on U S West - the two companies are neighbors in Denver and had a marketing partnership aborted by regulatory problems - but the Global Crossing merger seems to have a clear field.
Qwest and Level 3 represent the best candidates to pull the next Global Crossing-style shocker, because they both have market capitalizations in the vicinity of $30 billion to back up their big-impact ambitions. Qwest plans to do it by dominating multimedia and business applications, Level 3 by serving as the price-leading supplier of commodity bandwidth, mostly to service providers.
Wery sees Qwest or Level 3 as potential acquisitors in Europe. Deals between North American and European carriers - maybe even an AT&T-British Telecommunications merger - will constitute a key coming wave of consolidation, analysts said, reflecting huge traffic flows and business connections.
But just as MCI and the Bells have been taken over in this topsy-turvy consolidation, so too could Qwest and Level 3, if anyone can scrape up the price. Qwest may have its prom date, and perhaps eventual fianc‚, in investor BellSouth. Then again, "AT&T needs the kind of capacity that Qwest is building in order to participate in the broadband future," an industry executive said.
Handicapping Level 3 is problematic. As an acquisition target, Level 3 lags Qwest and others in construction of a network that eventually will be state-of-the-art. As a possible buyer, the company's insistence that it will build out its own local connections and stick to a carrier's carrier strategy doesn't jibe well with buying long-distance or local retailers.
Note, however, that competitors IXC Communications and Qwest also proclaimed wholesale-only strategies before succumbing to the temptation of buying traffic and revenue and adding ever-stickier and more sophisticated Internet services and business applications. Level 3 could end up owning an Internet provider such as PSINet if it makes the same flip-flop, one industry executive theorized.
Even low-profile, Dutch-based carrier Equant, with a strict focus on multinational corporate customers and the world's most extensive advanced telecom network, said the Global Crossing deal vindicates its global strategy - and Equant won't rule out acquisitions. Equant's stock price has quietly doubled since November 1998, giving it a market cap of about $18 billion.
The U.K.'s Cable & Wireless is hard to peg. Though a competitive player, it's a bit long in the tooth for an upstart, dating back as it does to the 1860s. The carrier is usually pegged as an attractive takeover target because it owns intriguing properties in an empire that is far-flung but too small and disparate for the big leagues. The value of a crucial piece, Hong Kong Telecom, is bound up with the management's long-standing and crucial ties to government authorities. So C&W, which bought MCI's Internet business for $1.5 billion last year and is trying to buy its way into the Japanese market, may surprise by eating instead of being eaten.
Then there are the openly ambitious unknowns. Global TeleSystems has aggressively expanded westward from its operating origins in the former Soviet Union; last year, it made waves by buying European competitive carrier Esprit Telecom. It was rumored to be after IXC, which remains in play. Another aspirant to the big-time, Canadian-based Teleglobe, seeks to clone the aggressive multilevel-marketing organization of acquisition Excel Communications for export to at least some of its hundreds of overseas markets.
These carriers share Global Crossing's drive, but so far they lack its savoir faire for charming Wall Street. Simply put: What counts now is stock market value, more than revenue or profit. Either presumably needs to push its market cap well above $10 billion if it hopes to become next year's model. Though Teleglobe's share price has roughly tripled in two years, Marketing Vice President Andrew Burroughs sighs, "it's still undervalued."
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