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Business Week: October 18, 1999
Cover Story
What It Will Take to Win
WorldCom's hurdles: The FCC, new technology--and antsy investors
Can 5 cents Sundays and Nickel Nights add up to more than 7 cents anytime minutes? MCI WorldCom Inc.'s $129 billion takeover of Sprint Corp. will create a colossus by any standard. But the $64 billion question about the biggest merger ever attempted remains: Is it enough to unseat AT&T as the No. 1 U.S. telecommunications company? WorldCom will have wireless, international, long-distance, and Internet businesses that, in many cases, meet or surpass those of the leader. And if all goes according to CEO Bernie Ebbers' plan, the new WorldCom may grow fast enough to knock AT&T out of the top slot. ''I expect that in five years, WorldCom will be considered the No. 1 long-distance company in the world,'' predicts Scott C. Cleland, an analyst with the Legg Mason Precursor Group.
Heady stuff. And as Ebbers stormed New York in a series of meetings on Oct. 5 to announce and explain the deal, the prospect of sitting atop a trillion-dollar industry had the 58-year-old entrepreneur walking on air. He strutted, grinning from beneath his trim gray beard, as he worked rooms full of journalists and financial analysts like a show-biz pro.
But Ebbers, who built his empire outside of Jackson, Miss., and kept it there to stay close to his country roots, remained true to form. ''I'm not the only cowboy around here anymore,'' Ebbers quipped, referring to Sprint CEO William Esrey's penchant for ranching, horseback riding, and cowboy boots. ''We're both wearing rented shoes today.'' Also, true to form, he did not miss the opportunity to disparage his rival, AT&T. He branded the long-distance leader the ''monopoly cable provider''--a dig at AT&T's fight to keep regulators from forcing ''open access'' to its cable-modem service.
Now, as the buzz from the dealmaking begins to fade, Ebbers heads back to Mississippi to figure out how to make this megamerger take off. Before he can start incorporating all those pieces that Sprint brings to the WorldCom empire, Ebbers must first get past a balky Federal Communications Commission. The size of the deal and the fact that it will create an enormous duopoly in long-distance has FCC Chairman William Kennard vowing to take a close look at the combination. By taking Sprint out of the game, 85% of the U.S. long-distance market will be in the hands of just two companies. The new No. 3, Qwest Communications International Inc., would trail with less than 2% of the market. ''You have two players, each 10 times the size of the next guy. And when you add the next 10 together, they're still half the size of these two companies,'' says Janney Montgomery Securities analyst Anna-Maria Kovacs.
TECHNICAL PROBLEMS. Also, while Ebbers has plenty of experience with mergers--there were more than 60 deals before this one--Sprint may present the biggest challenge yet (table). Integrating the networks and technologies of the two giants will likely take years, and WorldCom's freewheeling culture stands in sharp contrast to that of Sprint, based in Westwood, Kan. Besides, this time out, Ebbers does not enjoy unqualified support on Wall Street. While analysts applaud the strategic vision, they question the steep cost. Investors lopped 9.7% off of MCI WorldCom's share price since word of the proposed deal, including $14 billion in assumed debt, leaked out. And while Ebbers maintains that the deal will not harm operating earnings, some analysts are cutting estimates, just in case.
Furthermore, Ebbers must solve technical problems that could get in the way of providing high-speed ''broadband'' connections directly to customers. And he realizes that he will soon face more competition, possibly more dangerous than AT&T. At least with AT&T he might hope for a form of peaceful coexistence since his company is more focused on business markets, while AT&T is more consumer oriented (table). The bigger threat may come from the imminent entry into long distance of the Baby Bells, which have been straining to get into the business for years. Bell Atlantic Corp.'s petition for entry is already at the FCC, and the Sprint deal itself might encourage regulators to let others in soon. At the same time, Ebbers is revving up his efforts to compete with the Bells in local calling, primarily through new wireless connections. ''We're going to be significant competitors to the Bell operating companies,'' he declares.
Whatever the obstacles, Ebbers has no doubts about his fundamental strategy. It's simple: WorldCom, as the new company will be called, will be geared to providing customers--primarily businesses--with every variety of telecommunications service, from voice to data to Internet access, to wireless and international calling. WorldCom will have distinct advantages in Internet traffic and data communications, as well as operations in 65 countries. And Sprint's wireless division fills a long-standing hole in WorldCom's strategy.
For both WorldCom and AT&T, their current core business--U.S. long-distance--will shrink in importance. While MCI WorldCom's U.S. long-distance revenues are growing at 7% annually, sales of data, Internet, and international services are increasing by 40%. ''The juice is out of the lemon in consumer long distance,'' Ebbers says.
TOE TO TOE. In sheer size, WorldCom would clearly rival AT&T. The company would enjoy revenues of $54 billion, compared with AT&T'S $62 billion. And the new WorldCom's market capitalization of more than $200 billion would outstrip AT&T'S $133 billion. Together, MCI WorldCom and Sprint hold 23.5% of the consumer long-distance market--well behind AT&T's 60% share, according to Dataquest. On the other hand, MCI and Sprint together would match AT&T in business long distance. And in wholesale--hawking millions of minutes to resellers--the two control 51%, compared with AT&T's 19%.
From a marketing perspective, the combination gives WorldCom and Sprint the potential to do things that neither could do alone. Now, when WorldCom goes out to sell bundles of telecom services--long distance, Internet access, and wireless--it will stand toe to toe with AT&T, no longer unable to provide crucial bits, such as wireless. Eventually, Ebbers says, the company will sell its customers a bucket of minutes per month to be used however the customer chooses. As the network becomes completely digital and achieves broadband speeds, customers may simply buy capacity for Internet access or local or long distance--or even video. ''The long-distance business is not going to be long distance as we know it today,'' Ebbers says.
One key to that vision is the unsurpassed digital network that the two companies can assemble--a system with enough market share to raise hackles in Washington. The FCC might grant merger approval only after the company sells off some of the Internet backbone capacity. Together the companies control 43% of the U.S. access points to the Internet. The likely sacrificial unit would be Sprint's backbone business. ''One of the Internet backbones will have to be divested,'' says ABN AMRO analyst Kevin Roe.
Without question, the most important addition to WorldCom's portfolio will be Sprint's PCS unit. ''The gem they're looking at is the wireless property,'' says Roger Wery, head of the communications practice at telecom consultancy Renaissance Worldwide Inc. Ebbers flirted with a bid for Vodafone Airtouch PLC last year and negotiated with Nextel Communications Inc. last spring but finally balked at the financial terms of the deal. Although relatively small, Sprint PCS could prove to be a better deal than either. The carrier serves all of the top 50 markets as well as hundreds of smaller towns, and its data-transfer capabilities are currently second to none among wireless carriers--a key point for data-mad WorldCom.
DIRECT LINKS. And Sprint PCS is doing well. Its subscriber base has been growing furiously, with 2 million new customers this year alone. Also since it is represented by a tracking stock, the red ink the carrier has accumulated while building out its network is isolated from Sprint's balance sheet. To keep those same debts from diluting the earnings of the new company, Ebbers plans to exchange Sprint's PCS tracking stock--shares that entitle holders to the profits of high-growth divisions of companies but have restricted voting rights--for his own WorldCom PCS tracker.
But, Ebbers insists, the deal isn't just about wireless. He's also filling another gap: direct access to millions of customers--a business long controlled by the regional Bell operating companies. AT&T has made its bet on delivering voice, data, and video over cable, spending $110 billion to turn itself into the biggest U.S. cable operator. Sprint and MCI WorldCom have pinned their hopes on two technologies. The first is Digital Subscriber Line, high-speed connections that the company leases from local phone companies. But it's betting more on an emerging wireless technology that could, as AT&T is attempting with cable, give WorldCom its own direct links to customers. The largely untested broadband technology is called MMDS (for Multichannel Multipoint Distribution Service). AT&T is experimenting with similar technology.
Between them, WorldCom and Sprint have MMDS licenses for areas that include 60% of U.S. households. While MCI is downplaying residential long distance, it sees the high-speed wireless connection as a way to get into a more lucrative consumer market. ''This gives us the capability to get back in the home with an integrated service for broadband,'' says MCI WorldCom Vice-Chairman John W. Sidgmore. Analysts, though, are skeptical. ''The [Baby Bells] kicked that around a year ago and threw it out,'' says Yankee Group analyst Brian Adamik. Meanwhile, WorldCom does get some direct connections via the Sprint deal. The company, which traces its roots back to a local carrier called Brown Telephone Co., has 5 million local customers.
Sprint's ION service also provides potential for high-speed connections--once it works as planned. It's designed to let customers make phone calls, send faxes, cruise the Internet, and receive video signals--all without having to order multiple lines. But the service has been fraught with problems, and product delays from hardware suppliers have forced Sprint to operate ION with older, less capable equipment. ''ION is a joke,'' says one analyst. Brad Hokamp, Sprint's assistant vice-president for product development, counters that ION ''is revolutionary, and when you do revolutionary things, there's not going to be overnight implementation.''
Finally, Ebbers will have to untangle Sprint's dangling alliance with France Telecom and Deutsche Telekom, called Global One. ''The ownership structure of Global One can't go forward,'' says Esrey. He predicts that the alliance will break up sometime in the next couple of months. MCI has its own subsidiaries in France, Britain, and Germany and an alliance with Spanish network operator Telefonica.
Then there are the financial risks to the megadeal. At $115 billion in stock, MCI WorldCom is paying a premium of 50% over the market value of Sprint and Sprint PCS in the weeks preceding the merger. Although he kicked in an extra $20 billion or so to beat a counter-offer by BellSouth Corp., Ebbers says the deal is sound: He expects to see $9.7 billion in operating synergies--including consolidations--and a $5.2 billion savings in capital expenditures for the combined company between 2001 and 2004. Some analysts, though, question the math. Vik Grover at Kaufman Brothers LP, a New York-based investment bank, says the return on that investment will be ''less than you would make on a municipal bond.''
Muni bonds and Bernie Ebbers? Not likely. If his massive bet on Sprint and new technology pay off, he'll have a whole lot more than 5 cents Sundays and Nickel Nights to get his big payoff.
By David Rocks in New York, with Roger O. Crockett in Chicago, Catherine Yang in Washington, and Peter Coy in New York
Copyright 1999 The McGraw-Hill Companies, Inc. All rights reserved. Any use is subject to (1) terms and conditions of this service and (2) rules stated under ''Read This First'' in the ''About Business Week'' area.
10/8/99 10:04 AM
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