Jun. 30, 2003. 01:00 AM
The time is right for a telecom merger
TYLER HAMILTON
What Canada's telecommunications industry needs this summer is a big, fat merger, one that will get investment bankers excited about potential commissions and telecom reporters — ahem, that would be me — a break from covering the regulatory beat.
Yaaaaaawn.
We've all heard the rumours about Burnaby, B.C.-based Telus Corp. looking to acquire, at some point, that debt-free company formerly known as AT&T Canada Inc., now carrying the name Allstream Inc.
The benefits of such a deal are obvious: Telus would eliminate a major competitor, bolster its operations where it's weak — in the east — and add an A-list of corporate customers to its network. The same reasoning applied in 1998, when Telus — then headed by George Petty — entered merger talks with AT&T Canada that eventually broke off because of "unresolvable issues." Debt was probably a thorny part of those discussions.
There's absolutely no doubt that Telus chief executive Darren Entwistle has been crunching the numbers, weighing the pros and cons, and seeking advice on the matter. And he may yet pounce.
But aside from focusing his attention these days on a migraine-inducing union dispute, Entwistle currently finds Allstream too expensive. He expected, quite reasonably, that AT&T Canada's share price would fall after it was re-listed, as typically happens with companies that have gone through a major capital restructuring. The shares went higher instead.
There's also the fact that Allstream has a mish-mash of network assets that, in the words of one analyst, would make for "integration hell."
So while a deal may seem imminent, both companies say there have been no negotiations — "No open file" on the matter, in the words of Allstream chief executive John McLennan during the company's re-branding announcement earlier this month.
Two things could happen here. Entwistle will wait, solve his union dispute, and hope that Allstream has gone downhill during that time. Then he'll scoop it up. Or, something else will happen in the industry that forces Entwistle's hand.
Here's what should happen: McLennan of Allstream, Bill Linton of Call-Net Enterprises Inc. and André Tremblay of Microcell Telecommunications Inc. need to get together for a fishing trip in Muskoka. They should bring a deck of cards and a case of beer (a bottle of red wine for Tremblay), and after a day or two of loosening up, should start talking three-way merger.
The first criticism of such a scenario would likely be that bringing three weak, smaller players together won't lead to a bigger, strong player. Allstream, Call-Net and Microcell have struggled, and all three have been forced through capital restructurings over the past two years to stay in the telecom game. There's also the risk that comes with any merger, let alone a ménage à trois.
But let's look at a few facts:
All three have cleaned up their balance sheets. Together, a few billion dollars in crippling debt has been reduced to a very manageable $700 million.
Combined revenues would be in the area of $2.8 billion — still less than half the revenues of Telus, but certainly the type of critical mass needed to compete in a market dominated by virtual monopolies. The companies, each profitable on an operating basis, would instantly have about $425 million in cash.
All three are owned by former bondholders in search of an exit strategy or some way of adding value to their investments.
And, of course, each company brings complementary products and customers to the equation. Allstream, the biggest of the three, gets a majority of its business from large corporate customers seeking local, long-distance, Internet and data services. It also has a growing network management and systems integration business. About 80 per cent of Allstream's revenues come from just 4,000 big government and corporate customers.
Call-Net, parent of Sprint Canada, also serves some big corporate customers, such as Air Canada, but it has been more successful in serving small- and medium-sized businesses their data and telephone services.
Unlike Allstream, which sold off its residential long-distance business, Call-Net is very much in the residential and small-business market. It claims 175,000 local phone lines, and is moving ahead as the only major competitor in Canada going after local residential customers with a bundle of Internet, long-distance, local and, through a new resale agreement with Microcell, wireless services.
This brings us to Microcell, the obvious wireless connection. Bell has Bell Mobility, Telus has Telus Mobility, so shouldn't their largest competitor have a mobility arm as well? Doubts have been expressed that Canada can support a four-player wireless market, and Microcell has been cited as the one to go. But at least one credible study and a growing chorus of analysts are now questioning that assumption.
"Microcell has the necessary elements to prove that its restructuring was successful," wrote TD Newcrest analyst David Lambert in a recent report. The company also holds licenses for MCS spectrum, which can be used to provide high-speed wireless Internet services from coast to coast.
Microcell, Call-Net and Allstream bring together a full spectrum of telecommunications services, both wireless and wireline, and can deliver these services to residential customers all the way up to the largest corporate accounts. Product for product, customer for customer, they could go head-to-head at any table with Bell or Telus.
Let's assume they did see value in a merger. The next step is to look for cost savings. Call-Net has 1,700 employees, Microcell has 2,000, and Allstream is the largest with about 4,000 staff. Brought together, there would be many redundant managers, sales and marketing staff, and administrative folks, not to mention excess building space after any cuts. Big savings.
There would also be some redundant network assets, and co-location of equipment could be consolidated for additional cost savings. Microcell, today headquartered in Montreal, could move its head office to Toronto to take advantage of existing real estate.
From a brand perspective, the company could leverage the well-known Sprint brand that Call-Net continues to use under a new multi-year agreement with Kansas-based Sprint Corp., which currently owns 5 per cent of Call-Net.
Sprint may be more inclined to take a much larger stake in the merged company when Canadian foreign ownership restrictions fall over in the next year or two, as anticipated. That would mean ditching the Allstream name, but it's not like Telus would keep it, right?
What you're left with is Sprint Business, Sprint Residential, and Sprint Fido across three separate business operations. One sticky point could be that Sprint PCS in the United States uses CDMA technology on its wireless network, while Microcell Fido uses GSM. This causes a problem with cross-border roaming agreements, and there's no easy answer for solving it.
Now, let's talk management. Who would be the CEO? The obvious answer is Allstream's McLennan, a well-respected and clever industry veteran who has run the shop at both Bell Canada and Bell Mobility. He knows how to play the regulatory game and to anticipate Bell's moves.
By McLennan's side as president and chief operating officer would be the more technical John MacDonald, also a Bell-family veteran, who is today doing the same jobs at Allstream. Bill Linton, a well-liked executive outside of regulatory circles, would be an ideal chairman. The fate of Tremblay and his management team is an open question I won't answer here.
So what's the chance of this happening? Setting aside here the power of suggestion, I'd say it's fairly slim.
On the other hand, McLennan told me recently that, at some point, Allstream will need to consider new markets if it hopes to grow the business. About 20 per cent of Allstream's revenues come from New York-based AT&T Corp., but those revenues are in question now that an exclusive partnership between the two companies has ended.
"We're not against expanding our business opportunities in any way," said McLennan, adding that doing so would have to "dramatically" improve the company's competitiveness against Bell and Telus.
Asked about a theoretical merger with Call-Net and Microcell, McLennan said all scenarios have been looked at.
"We're considering many different things and that's obviously one of them," he said. "When you combine those kinds of services, what kind of synergies are you going to get? ... You can mould that into a company that may be half the size of Telus, but ... can you drive that business and make it profitable for shareholders?
"If you can't, and are going to get dragged down with their problems, then you really have to be careful what you do ... You're really betting the whole farm."
Would McLennan ever bet the farm?
"We're always looking at it, we're always analyzing it — we have people analyzing this stuff to death," he said. "I will bet the farm if I think there's a real opportunity to grow shareholder value and have stability and growth."
It would be risky, and it would be challenging work, but the opportunity is there in my view. Problem is, there's only one chance, one window of opportunity.
Once Telus overcomes its union problems out west, Entwistle will refocus his attention and may finally decide to scoop up Allstream, one of the few remaining telecom competitors in Canada. This would wipe away a major contender in the market that has challenged the incumbents for more than 150 years.
John, Bill, André — it's time to crack open a couple of cold ones.
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Tyler Hamilton writes about technology and the Internet Mondays in @Biz. Reach him at thamilt@thestar.ca
Additional articles by Tyler Hamilton
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