US telcos Sprint for the line
Competition hotting up
Analysis The face of US telecoms has changed dramatically in the past year. Following the consolidation of the cellular sector with the mergers of Cingular Wireless with AT&T Wireless, and then Sprint with Nextel, the most dramatic of them all has been agreed – the acquisition of AT&T by SBC, one of the regional ‘Baby Bells’ it was forced to spin off when its monopoly was broken up.
Apart from the potential loss of a venerable brand, the shock value lies in the price and the ease with which the transaction is expected to pass regulatory hurdles. A few years ago, few could have conceived of AT&T being sold for just $16bn, and for the antitrust and communications agencies not to be concerned.
This demonstrates not just a current regulatory climate that is very friendly towards the Baby Bells or RBOCs (SBC, Bell-South, Verizon and the far smaller Qwest), but the collapse in value and perceived importance of AT&T and its primary business of long distance lines. Further mergers may well be triggered – Verizon, currently the largest RBOC, is said to be interested in buying another long distance carrier, MCI, while Sprint, which plans to spin off its own long fixed line business, could put that up for sale.
The net result – assuming, as most people do, that Qwest will be acquired – could be a US telecoms industry based around three RBOCs, each controlling the local loop, long distance links, cellular operators (SBC and BellSouth through their Cingular joint venture, now the largest US cellco), and increasingly pushing into the ‘quadruple play’ of delivering voice, video, data and mobility to residents and enterprises. (We can assume, or at least hope, that even the current regulatory climate would not permit the confessed dream of SBC chief Ed Whitacre, of merging with BellSouth to gain full control of Cingular).
Counterweights to the RBOCs
The only challenge to these massively powerful operators will be the cable operators, themselves looking to enter the mobile and broadband wireless sectors, and suffering far less heavy regulation than the RBOCs; cellular services run under MVNO (mobile virtual network operator) deals, in which they lease capacity on a 3G or, in future, WiMAX network; and the biggest of the ISPs, with Clearwire, SK-Earthlink and AOL all looking to deliver quadruple play on a national basis.
Consolidation has become imperative for the RBOCs as these competitors get stronger, and they seek to rely on sheer weight and bullying power to fend off newer challengers, from municipal hotzones to broadband wireless ISPs.
The other contender will be Sprint-Nextel, which has no local operations but has the huge double advantage of a national cellular network on which it has built an extremely successful MVNO business, which may well be the basis of the cableco’s mobile push; and the spectrum to build a parallel broadband wireless network for enterprise services and for MVNO use.
Impact on WiMAX
While Sprint may gain from the consolidation, if it turns the situation to its advantage and becomes the key ally of all the challengers to the RBOCs, Clearwire has a similar opportunity on the broadband wireless side. However, it will suffer, short term, from the takeover of AT&T, as may Intel – both companies were becoming increasingly close to the telco, with major joint ventures surrounding WiMAX equipment and services, and AT&T was widely expected to lease Clearwire’s evolving capacity for its own grand WiMAX plans.
These plans will not be on hold, since their main motivator was to enable the telco to bypass paying fees to the RBOCs to deliver services to the last mile. While SBC has made broadband wireless part of its ambitious planned next generation network, this will be a small piece compared to its massive fiber roll-outs. It may also use WiMAX to avoid paying fees to fellow RBOCs outside its territories, but this roll-out will almost certainly be more patchy than AT&T’s plan would have been.
While not important for WiMAX long term – at least, as long as other national plans such as Clearwire’s and SK-Earthlink’s remain on track, delivering very advanced services to the US consumer and business – in the short term AT&T’s aggressive timescales would have created an early major boost to the new market, stimulating confidence and volume.
Who will be next?
The SBC deal has, naturally, sparked speculation on who will be next, since both Verizon and BellSouth seemed more inclined to grow through their own acquisitions than by counterbidding for AT&T. The main candidates are MCI (formerly WorldCom) and Sprint, which is looking to spin off its long distance wireline business, but which could also be a more ambitious target in its entirety.
Verizon will be pushed into a close second place in the US telco stakes by the SBC-AT&T merger, as its wireless arm was by the Cingular-AT&T Wireless marriage. In both markets, its aggressive organic growth strategy could well enable it to regain its top spot without further acquisition, but most analysts expect it to make a play for another telco at some point. However, this may not be immediate – Verizon could have made a counterbid for AT&T, but is likely to be retaining its resources for a different purchase, buying Vodafone out of its 49 per cent stake in Verizon Wireless. However, since failing in its own bid to acquire AT&T Wireless, Vodafone seems intent on retaining its presence in the US market by clinging on to its Verizon Wireless stake.
This stand-off is unlikely to be resolved soon, since Verizon Wireless is becoming an increasingly attractive asset, and the other options for Vodafone (or Verizon) in the US mobile market are fading fast. Cingular Wireless would be a massive acquisition with all kinds of integration risks plus almost certain regulatory problems. Deutsche Telekom shows no signs, these days, of wanting to sell its T-Mobile USA unit, and this is too spectrum starved to be a great attraction to Vodafone anyway, and falling behind in the 3G roll-out race.
This leaves Sprint-Nextel, now the third US cellco. Indeed, if Verizon, or indeed Vodafone, is looking for a major buy, all roads have to lead to Sprint. The newly merged company has some migration headaches ahead for Nextel’s ageing iDEN network but it has good national cellular coverage as well as the undervalued asset of its national WiMAX-suitable spectrum holdings in 2.4GHz. Nextel was famously profitable and resistant to customer churn, while Sprint has, in the past two years, accomplished much of the turnaround that potential acquirers would have been forced to take on themselves in its darker days. It also has advanced plans to spin off the wireline business, which could be carried through by a purchaser if it decided to stay out of that constricting area of operation – as Vodafone almost certainly would.
Although we see Sprint as the real catch in the US telecoms market, it is on MCI that most of the speculation is centering, partly because it has made little secret of its willingness to be acquired and a deal would face fewer regulatory hurdles. MCI emerged from bankruptcy protection in April last year, and now has less debt than AT&T and $5.6bn in cash. It would be a fairly cheap purchase, with its market capitalization being $6.5bn, less than half of AT&T’s.
However, it also has only half its larger rival’s market share in the enterprise sector and it is less efficiently run. It is investing less in its networks than its competitor and has margins eight percentage points lower (after deducting access fees paid to the RBOCs). Its main benefits to Verizon or BellSouth would be to enable them to bundle in long distance services with local, and to give them a better foothold in the enterprise voice and data sector. But it has a tarnished brand and the enterprise market itself is losing margin rapidly.
The RBOC showing the most immediate interest in MCI is Qwest, the smallest of the four and itself keen to find a buyer. It is in merger talks with MCI, and is said to be offering about $6.3bn. Verizon could easily outbid this price, of course, and the talks may provoke it into action. Qwest has market value of about $7.7bn but debt of $17.2bn, and is well behind the other Bells in rolling out broadband networks.
MCI would at least bring it greater flexibility with its debt and some cash. However, it would be a merger of two weak players and it is hard to imagine it being able to make a significant turnaround. Instead, it could become a rather more attractive acquisition prospect than either partner is on its own.
BellSouth’s reaction will be interesting too. Like Verizon, it may be keen to gain access to long distance and global networks in its own right, rather than having to pay a third party, now that SBC has made this move with AT&T. It, too, could make a bid for MCI, with or without Qwest involved, or could go for Sprint. Like Verizon, such a bold move might involve a change of relationship within its current cellular joint venture (it holds 45 per cent of Cingular).
Buying MCI would smack of the RBOCs chasing size and weight at the expense of a forward thinking strategy. Sprint, for all the complexities of the merger process, would speak of a far more creative approach to the next generation network and the quadruple play. However, we hope Sprint-Nextel is preserved from the RBOC clutches to remain one of the best counterbalances to their growing power.
Further background: The SBC-AT&T deal:
The acquisition is a mainly-stock transaction which creates a company with $70bn in sales and over 200,000 staff. SBC expects, if the deal is approved, to generate about $15bn in cost reductions through consolidation of workforces, headquarters and other operations. The company overtakes Verizon as the US’ largest telco. CEO Edward Whitacre will remain in his position while AT&T chief David Dorman is expected to be president.
SBC offers voice and DSL services to 50m customers in 13 states in the west and Midwest and is now upgrading its network to support fiber to the home and the quadruple play in many areas.
AT&T has 30m customers and has upgraded its global fiber network over the past few years to be one of the most advanced in the world. It has about 3m business contracts, which will be one of its chief attractions to the residentially-focused SBC. Its global network spans over 50 countries and it manages 26 advanced internet data centers round the world.
SBC CEO Edward Whitacre said: "The communications industry is undergoing a profound transformation as it transitions to unified, IP-based networks capable of delivering a host of integrated services. To manage this evolution, customers need a partner with the resources to provide new service platforms and product sets, while maintaining world-class reliability and security. This merger creates that company."
Under the terms of the agreement, approved by the boards of directors of both companies, shareholders of AT&T will receive total consideration currently valued at $19.71 per share, or $16bn. AT&T shareholders will receive 0.77942 shares of SBC common stock for each common share of AT&T. Based on SBC's closing stock price on 28 January, this exchange ratio equals $18.41 per share. In addition, AT&T will pay its shareholders a special dividend of $1.30 per share.
Copyright © 2004, Wireless Watch
Wireless Watch is published by Rethink Research, a London-based IT publishing and consulting firm. This weekly newsletter delivers in-depth analysis and market research of mobile and wireless for business. Subscription details are here.