Good morning, America: BT goes the distance

Richard Halstead surveys the proposed merger with MCI - the biggest deal in UK corporate history

The partnership started three years ago when British Telecom paid $4.2bn for a 20 per cent stake in MCI, America's second largest long- distance telephone company, and launched a joint venture called Concert.

On Friday came the marriage proposal. At 1.30pm MCI's share price was suspended, having risen 15 per cent to $30 (pounds 18) a share, and the company announced that it was talking to BT about a merger. The BT and MCI boards both met yesterday.If they decide to go ahead, the markets envisage a bid by BT for the remaining 80 per cent of MCI of around $35 a share, valuing the company at $22bn.

If the deal were to go through, it would immediately shift the balance of power in world communications. For the first time BT would have access to the local phone market in the US, thanks to recent deregulation legislation; the company would exploit MCI's link with Rupert Murdoch's News Corporation in satellite television and Internet services; and, with Concert subsumed in a merged BT-MCI, the company could make a much better case for supplying the communication needs of the multinational business community - supplanting AT&T as the number one international telephone company.

BT's chief executive, Sir Peter Bonfield, has been in the job for only 11 months. In that time he has presided over the collapse of one mega- merger, with Cable & Wireless, which would have stretched BT's global reach eastwards. Now he faces the possibility of leading the first truly global telecoms company.

While London analysts were struggling to come to terms with the announcement, telecoms strategists on the other side of the Atlantic were applauding. "BT has once again demonstrated its ambition to become a leading player in the global telecoms market, and now is the time to do it," said one.

The Cable & Wireless deal would have offered BT a lucrative slice of the Asian market via C&W's stake in Hongkong Telecom. But it would also have involved a myriad of government hurdles, the divesting of Mercury Communications, and a cost of of up to pounds 10bn to buy out minority interests in Hongkong Telecom and pay a special dividend to C&W shareholders.

The MCI deal, which is thought to involve shares with a cash alternative, may also prove quite expensive - but telecoms observers believe it offers many more opportunities.

The scale of the proposed marriage has taken the financial world by surprise. If a conventional purchase by BT of MCI's outstanding stock were to happen, it would be the largest takeover in UK corporate history, eclipsing the pounds 10bn merger of SmithKline Beckman and Beecham Group, and Glaxo's pounds 8.9bn takeover of Wellcome. It would also rank as the second biggest deal in the US, behind Kohlberg Kravis Roberts' $24bn leveraged buyout of RJR Nabisco. If, however, a reverse takeover by MCI of BT was preferred, to get around regulatory obstacles, the price would be close to pounds 35bn - making it the largest takeover of all time.

The link-up would create a company with $37bn in annual revenues - smaller than AT&T, which reported revenues of $50bn last year from its telecoms operations (excluding NCR, which it intends to demerge). But its global reach would make it the world's largest international telecoms company, eclipsing both AT&T and NTT of Japan.

BT would be competing on the home ground of AT&T and the "Baby Bells", the local US phone companies spun off from AT&T when it was ordered to break up its monopoly in 1978. A combined BT/MCI would be in a strong position to compete, but at the same time it would be thrust into the confusing world of the recently deregulated US telephone market.

At stake in the US is MCI's ability to transform itself from a company that simply provided long-distance telephone services to an integrated phone, satellite TV, Internet and mobile-phone provider. Under legislation passed in the US last year, long- distance providers can compete directly with local phone firms, and vice versa.

Both BT and MCI are anxious to take the lead in providing worldwide telephone and electronic services to the 5,000 or so multinationals that now require reliable, bespoke communications. Last year the Concert joint venture, set up for this purpose, recorded $1.5bn of revenues from its telephone operations, and earlier this year it announced it would launch an upmarket Internet service for its global business customers.

Since Concert's launch, however, AT&T has formed strategic alliances with the national phone companies in the Netherlands, Switzerland and Spain. In addition, Sprint, a competitor to MCI in the US long-distance market, sold a 20 per cent stake in its operations to a consortium of France Telecom and Deutsch Telecom.

Meanwhile, the core markets of both MCI and BT have been eroded by deregulation. In BT's case, this has taken the form of increased competition from cable companies in local phone services, and in the business market from Mercury Communications and AT&T itself, which recently launched a sales campaign to gain business clients in Britain.

The problem for MCI is the possible loss of its long-distance revenue while its other operations struggle to get off the ground. It already has a local phone service called MCImetro, which contracts with local phone operators for network time; a contract to sell PCN mobile-phone services, the American equivalent of the GSM standard; and a joint venture with News Corporation to provide satellite TV. But all the projects are at an early stage and the satellite operation in particular has been experiencing teething problems.

Advisers to the company this weekend stressed the benefits of combining BT's knowledge of local telephone service with MCI's experience in serving the international business market. But they added that the deal was not yet done. US legislation from 1934 prohibits foreign firms from owning more than 25 per cent of a domestic communications company, and when BT took its MCI stake in 1993 it undertook not to raise its stake for 10 years. However, the Federal Communications Commission has indicated it will consider waiving the restriction if the foreign company's own market is open to competition.

Another pitfall may be MCI's News Corp joint venture. Last year MCI paid $2bn for a 13 per cent stake in Murdoch's empire, and threw in its recently won $600m satellite broadcasting licence. BT was not permitted to have any part of the deal because of UK legislation preventing BT from entering the broadcasting market. It is hard to see that position being reversed, so BT may have to sell the stake.

Meanwhile, the complexity of the US phone market cannot be underestimated. Last year the Telecommunications Act ostensibly opened up the long-distance and local markets to all-comers. The result was a flurry of deals among the local phone companies, culminating in Bell Atlantic's merger with Nynex. The combined "Big Bell" has seamless coverage down most of the eastern seaboard, and is now allowed to route long-distance calls, at little cost, along its network.

In the UK, BT retains command of the business and residential market, but its lead is being steadily eroded by AT&T's aggressive offers to the business community, and by the cable companies' efforts in the residential market. BT and MCI will be looking to establish high-margin, high-quality business services to replace the falling revenue from residential line rentals and long-distance charges.

Turning the deregulated market on both sides of the Atlantic in BT-MCI's favour must be the first priority. However, if the merged company could achieve a solid market position in the US and maintain its dominance in the UK, there would seem to be little stopping it from sweeping weaker and more parochial European brethren before it. Maybe AT&T has finally met its match.

BT

Privatised: November 1984

Turnover, 1995: pounds 14.5bn

Pre-tax profits, 1995: pounds 3bn

No. of employees: 128,000

Significant events:

1986: Buys 51 per cent of Mitel, Canadian Telecoms maker, for pounds 156m. Sells in 1992 at a loss of pounds 135m.

1989: Buys 20 per cent of McCaw, US mobile phone group, for pounds 980m. Sells stake in 1993 to AT&T for pounds 1.2bn.

1993: Buys 20 per cent of MCI for $4.3bn.

1996: March - calls off talks with Cable & Wireless over pounds 33bn merger.

1996: November - Announces it is in merger talks with MCI to create group with market capitalisation of pounds 35bn.

MCI

Founded as Microwave Communications Inc in 1963

Turnover, 1995: $15.3bn

Pre-tax profits, 1995: $897m

No. of employees: 50,000

Significant events:

1978: Landmark court ruling breaks AT&T's monopoly on long-distance phone services and orders break-up of local network.

1993: Sells 20 per cent stake to BT for $4.3bn and launches Concert, a global joint venture with BT.

1995: Agrees joint venture with News Corporation to develop MCI's national US direct broadcast satellite licence and provide internet services. Agrees to take 13 per cent stake in News Corp.

1996: November - announces merger talks with BT

MCI

Founded as Microwave Communications Inc in 1963

Turnover 1995: $15.3bn

Pretax profits 1995: $897m

Number of employees: 50,000

Significant events:

1978 Landmark court ruling breaks AT&T's monopoly on long-distance phone services and orders breakup of local network

1993 Sells 20 per cent stake to BT for $4.3bn and launches Concert, a global joint venture with BT

1995 Agrees joint venture with News Corporation to develop MCI's national US direct broadcast satellite licence and provide internet services. Agrees to take 13 per cent stake in News Corp.

1996 November Announces merger talks with BT