COMMENT : Reasons for reservation amid merger euphoria

`If this deal is to be sanctioned by Oftel and the Office of Fair Trading, it must be made conditional on Mercury being sold to a credible and serious competitor to BT'
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Nearly everyone, it seems, wants to see the British Telecom/Cable & Wireless merger succeed. BT's Sir Iain Vallance is just desperate to see it happen. Internationally, C&W is a perfect fit for BT and would almost certainly help to get BT's flagging share price out of the doldrums. Rudderless at the top, C&W would agree almost anything that provides a little direction, the price being right of course. Ministers too are keen to encourage the get-together. They see an opportunity to create a leading world company, a telecoms behemoth to rival AT&T of the US. And then there's the City. Mouth-watering fees are in prospect. The gaggle of investment bankers and other advisers involved in this deal would kill to ensure it happens, if that were thought necessary.

This is not a merger without pain, however. As with all rationalising takeovers, there are going to be big job losses, possibly running to the thousands. Furthermore, C&W will have to be effectively dismantled with important interests sold or closed, to steer the merger through the regulatory minefield it faces. And while this is a deal that might well be in the interests of "Great Britain plc", it should not be forgotten that BT's monopolistic instincts, though in retreat, are still mighty powerful ones. If BT can use this takeover as a way of weakening domestic competition, of further entrenching its own position, it certainly will, make no mistake about it. There will be lip-service to the safeguards and disposals necessary to ensure adequate competition, but the underlying game plan is to hang on to as much of C&W as possible. Otherwise some of the purpose of the deal from the point of view of the shareholder is undermined.

Which is why, if this deal is to be sanctioned by Oftel and the Office of Fair Trading, it must be made conditional on Mercury being sold to a credible and serious competitor to BT. If BT gets its way, this will not occur. BT accepts that it will have to sell Mercury, its still-fledgling main rival in the UK, but it doesn't want to do anything that would make Mercury a more powerful competitor. An enfeebled Mercury that looks like a rival but in practice is too small and financially weak to challenge BT is what BT is after. Floating off Mercury, or selling to a venture capital-backed management buyout team, is BT's option of choice.

To Sell to AT&T would, for BT, be the equivalent of inviting a worst enemy into your own backyard.

Here is a company that would give BT a run for its money. Indeed, the danger for BT in this takeover is that the regulatory price of the deal would be the establishment of a far more threatening rival in its own domestic market than presently exists.

This obvious downside probably doesn't outweigh the supposed benefits on the international side, but it is a mighty powerful consideration that could alter the arithmetic of the takeover appreciably. There is also a quite separate regulatory problem in selling to AT&T. The Government would be reluctant to allow a US takeover of such a key British telecoms company while the US prevents British companies from controlling US telecom players.

Until the Government reaches a conclusion on these key regulatory issues, it is hard to see how the deal can be moved forward, however close the two sides are on agreeing terms.

Labour facing two ways on Railtrack

Clare Short's contribution to the Railtrack privatisation prospectus sounds tough at first glance. There is a smell of old Labour in its talk of clawbacks, public ownership, redirection of subsidies, intervention in investment and political control of the regulator.

But on a second reading it looks not so much tough as facing in two contradictory directions. The policy contains some tough nuggets, including a much enhanced version of what the City has come to call regulatory risk for rail investors.

John Swift, the rail regulator, will be brought under direct political control and his wings clipped, with ministers given greater power to remove him from office. This appears to be on the grounds that the railways are different from other utilities in that they rely on taxpayers' money.

Ministerial interference is something extra for investors to worry about in the Railtrack privatisation. On the other hand, Professor Stephen Littlechild, the electricity regulator, has managed to cause plenty of disruption in the markets all by himself, without any help from Government. Investors in utilities have grown accustomed to a rough ride and will probably take this in their stride.

Property development profits will be curbed, with the company allowed to keep substantially less than the 75 per cent the regulator has agreed. But that probably won't give too much concern, either. Property income is about pounds 120m a year, the vast bulk is from rentals and analysts have not been factoring in any development bonanza to their Railtrack valuations.

The lottery element in buying the shares will be removed - there will not even be an outside possibility of huge windfall gains. But that will not knock a very large hole in valuations of the shares.

Elsewhere in the policy details too, there appears to be rather less than meets the eye. Labour will "dependent on the availability of resources, and as priorities allow, seek, by appropriate means, to extend public ownership and control over Railtrack". Translated, that means Gordon Brown will not let his transport colleagues promise a penny of extra public spending to renationalise the railways.

But the most important point, which you would expect from Tony Blair's New Labour, is that there will be no expropriation of assets or abrogation of contracts. Ms Short says: "There is no question of existing contracts being cancelled against the wishes of the parties to them. Rather, the mechanisms which the existing contracts already provide for will be used to their full potential. The exercise of these powers will not involve the expenditure of public money."

Since the present relationship between train franchisees and Railtrack - including the way access charges are set - is enshrined in a web of detailed contracts, this appears to put off any radical change until the franchises expire in seven to 15 years' time.

In other words, Ms Short may want to redirect subsidies from the franchise companies to Railtrack to exert more control over the system, but she is committed to doing nothing unless the companies involved agree to renegotiate.

The end result of Labour's proposals is additional uncertainty that may deprive taxpayers by marginally reducing the Railtrack sale price. But it will not stop the sale, the action promised by John Prescott, deputy leader, when he first set out Labour's stall on rail privatisation.

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