BT in pounds 35bn merger talks to create the world's second-largest telecoms company

British Telecom last night said it was in merger talks with MCI, its US partner in which it has a 20 per cent stake, to create the world's second-largest telecommunications company after Japan's mighty NTT.

The merger would involve BT taking over MCI by buying the remaining 80 per cent of the company it does not already own, valuing MCI at $21bn (pounds 12.8bn). BT's current stock market value is pounds 22bn.

BT paid $4.3bn (pounds 2.6bn) for its 20 per cent stake in MCI in 1994, beginning a partnership in global communications which includes its joint venture business communications company, Concert.

The dramatic series of events began when MCI shares were suspended in the US at 1.30 pm New York time yesterday (6.30pm UK time) as speculation about the talks mounted. Shortly beforehand, MCI's share price had climbed more than 16 per cent, to $30.62.

Confirmation came first from MCI and then from BT. In a statement BT said: "BT acknowledged this evening that is it considering a possible strategic merger with MCI. BT's board will meet over the weekend to consider an anticipated proposal from MCI.

"BT anticipates that it will be able to make an announcement prior to the opening of the London markets on Monday. BT and MCI have both said that there can be no assurances that an agreement will be entered into or that any transaction will be consummated."

The combination of BT and MCI would be larger than the US's biggest telecommunications group, AT&T. In terms of sales and profits BT is by far the bigger of the two companies. Last year MCI had sales of $15.3bn (pounds 9.6bn) while BT's turnover was pounds 14.5bn. MCI made pre-tax profits of $897m (pounds 564m) compared with BT's pounds 3bn.

In terms of employees, BT has 125,000 staff in the UK and some 3,000 overseas, while MCI has around 50,000 workers.

If the two sides can agree on a price, the next hurdle will be obtaining regulatory approval in the US. Last night, Tom Boasberg, the senior legal adviser to the US watchdog, the Federal Communications Commission, said the announcement had come as a complete surprise and no application had been made to authorities in Washington.

"This is the first we've heard of it. We were in a meeting and someone came in and told us it was on the television," he said.

The merger would need to clear rules which limit foreign holdings in US firms to 25 per cent. Mr Boasberg explained: "The crucial test is whether it is pro-competition for US consumers. The key is to what extent the foreign market, in this case the UK, is open to US firms."

Although the UK has one of the world's most deregulated telecommunications markets, the process of gaining US official approval would still take several months.

Another possibility involves a successful outcome to World Trade Organisation talks about opening up world telecommunications markets.

The deal would also cement an increasingly close relationship between BT and Rupert Murdoch. Directors of MCI include Sir Peter Bonfield, BT's chief executive and Mr Murdoch. BT and News International revealed plans in September to launch an internet service for the UK consumer market called Springboard.

In May 1995 MCI and Mr Murdoch's News Corporation signed a deal to create two joint venture companies offering satellite television services to consumers, American Sky Broadcasting and SkyMCI.

The merger would be the culmination of the drive by Sir Peter and the BT chairman, Sir Iain Vallance, to expand BT's horizon's overseas. It leaves one piece of the international jigsaw missing - the elusive link- up with NTT of Japan.

However, BT already has joint ventures in France, Germany, Italy, the Netherlands and Spain. Last month it forged an alliance with the French utility, Compagnie Generale des Eaux, by paying pounds 1.1bn for a 25 per cent stake in a new telecommunications group Cegetel.

The link-up with MCI, the world's third-largest long-distance telecoms company, follows the failure of BT and Cable & Wireless to agree a pounds 33bn merger earlier this year.

That deal foundered over price and the difficulty of getting regulatory approval in Europe, Hong Kong and the US.

The two most important European alliances forged so far by BT are in Germany, the largest telecommunications market on the Continent, and France. Last year it signed a deal with Viag in Germany to set up a telecommunication service in Germany to compete with Deutsche Telecom.

The alliance with Viag will enable BT to cover 80 per cent of the German population and will provide services to business and residential customers.

Viag InterKom, based in Munich, will also offer international telephone and data services supplied through Concert. BT's French partner, CGE, already operates the number two mobile telephone operator in France, SFR which has more than 700,000 customers.

But Cegetel will apply for a fixed licence to operate a full range of services from 1 January 1998.

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