WRONG NUMBER

The City is drooling over the prospect of huge fees, but would BT's planned pounds 35bn link-up with Cable & Wireless really equip it to take on the world?

THIS weekend some of the City's most influential bankers are locked in intensive talks to try and agree terms on the biggest deal in British corporate history.

They will forgo their annual Easter skiing trips to Vail or Val d'Isere to thrash out details of a proposed merger between British Telecom and Cable & Wireless that would form Britain's biggest company - a telephone giant worth more than pounds 35bn.

The stock market is drooling in anticipation of a successful outcome. But while C&W may be the most easily available vehicle for BT's international ambitions, amid all the gloss doubts are growing about how well-placed the deal actually leaves it to take on world competition.

The worries have yet to feed through to the market. Shares in both companies have rocketed since news 10 days ago that merger talks, suspended only last month, were back on. And a battery of corporate financiers, accountants, lawyers and other advisers stand to make a fortune.

"It will produce record fees of around pounds 300m for the City," says Philip Healey, editor of specialist magazine Acquisitions Monthly. "There have been at least two earlier attempts to do a deal, but this time it looks as if there is every likelihood that they will get together."

BT is being advised by blue-blooded merchant bankers NM Rothschild, while American investment bank Goldman Sachs and the Anglo-Dutch financiers ING Baring act for C&W.

But it is more than just the enticing prospect of a huge cash windfall on just one deal that has investors excited. Driven by an unprecedented combination of sweeping technological change, government deregulation and increased competition, the world telecommunications industry is undergoing a revolution.

In the digital age everything - not just basic fixed telephone lines and mobile phones - is up for grabs. The full panoply of electronic communications - from video phones to Internet access and satellite TV - is being fought over in a series of alliances and takeovers.

Across the world, cosy state-owned telecoms monopolies are being dismantled as domestic markets open up to competition. The upshot for phone users everywhere should be cheaper calls and lower bills.

"Phone calls are overpriced compared to other forms of communication," argues Jacob Palme, a computer science professor at Stockholm University. "The least competition is for lines into the home where phone companies still exercise a virtual monopoly. That's why they make such high profits."

But technology is making it possible to conduct business and communicate in cheaper, more efficient ways that bypass traditional phone usage. Take the Internet. Communication by electronic mail is its most popular use. Unlike phone calls, faxes or conventional mail, the cost of e-mail is not dependent on how far the message has to travel, making it a big cost saver for international data traffic.

Mr Palme believes an average business call takes 20 minutes, including three unsuccessful attempts to reach the right person. E-mail, by comparison, takes less than five minutes. "For small simple messages and for group communication e-mail is more efficient. And you don't have to interrupt other people."

The Internet, which could have up to 200 million users by the turn of the century, may also provide a medium for cheaper telephone calls, video- conferencing and interactive television.

On the regulatory front, the most significant changes are taking place in the US. In February President Bill Clinton signed the Telecommunications Act, removing US barriers between cable, local and long-distance phone services that a wired world had made archaic. At a stroke, the Act turned on its head US policy that in 1984 saw the break-up of national telecoms giant AT&T in the most dramatic anti-trust action the world has ever seen.

Now the new law allows the seven regional "Baby Bell" operators spun off from AT&T - "Ma Bell" - to compete with long-distance carriers in their $76bn US market. It also grants access to the even bigger local- call market to AT&T, MCI and Sprint, the three dominant long-distance carriers. The fall-out from the Act is already being seen. Last week two of the Baby Bells, Texas-based SBC Communications (better known by its old name SouthWestern Bell) and California's Pacific Telesis, unveiled a $50bn (pounds 33bn) deal - almost identical in size to BT/C&W - to form America's second biggest telecoms operator after AT&T.

Europe is not far behind in the liberalisation

stakes. All 15 members of the European Union, plus Switzerland and Norway, are preparing to open their doors to competition by the beginning of 1998.

In the Far East the Japanese government is considering whether to break up NTT, the state-owned monopoly and the world's largest telephone group in terms of turnover. China, the Philippines and Malaysia are also inviting competition - and badly needed investment - for their existing services. These developing countries realise that their communications infrastructure must be improved if their economies are to thrive in the information age.

Globally, the World Trade Organisation also hopes to negotiate a pact on fair access to national telecoms markets by the end of this month.

Analysts believe that only half-a-dozen super-carriers will survive this shake-out to become truly global players. Hence the importance being attached to the BT/C&W talks, which would create a national telecoms champion to compete with the world giants: NTT, AT&T and Germany's Deutsche Telekom.

But even before the agreement is consummated, increasingly it looks as if the deal is not so much a merger made in a heaven but, at best, a marriage of convenience.

"The real driving force behind the deal is that both of them are in a bit of a hole," argues Jo Oliver, telecoms analyst at NatWest Markets. "For BT the latest document from the industry regulator Oftel about future pricing in the UK is absolutely appalling. It envisages profits falling by 25-30 per cent."

For its part, C&W is rudderless following the abrupt departure last year of executive chairman Lord Young and his chief executive James Ross after a very public spat over the group's strategy, which was widely seen as lacking in focus and direction. Its Mercury subsidiary, for example, where C&W has an 80 per cent stake, has conspicuously failed to make a serious dent in BT's old monopoly control of the UK market.

Despite the presence of 150 groups licensed to offer telephone services in the UK, BT has held on to 92 per cent of the residential phone market and 76 per cent of the business market.

Oftel, though, has now sharpened its attack on phone charges and BT and Mercury are also likely to lose their cosy duopoly on handling international calls. To escape this regulatory bind at home, BT is keen to expand overseas. Teaming up with C&W, with its loose-fitting "federation" of licences in more than 50 countries in the Caribbean, Europe and the Far East, seems to make strategic sense.

The jewel in the C&W crown is its 57.5 per cent stake in Hong Kong Telecom, worth pounds 8.4bn, which offers an excellent gateway for BT into China and the "tiger economies" of the Far East.

Such is the value of this asset that the deal is being structured so that the smaller C&W will launch a reverse takeover of the larger BT. That would avoid BT having to make an offer for the rest of Hong Kong Telecom that C&W does not own.

The looming problem, nonetheless, is that more than a third of the combined BT/C&W's profits and assets will be subject to the whim of the Chinese government after Peking takes back control of Hong Kong from Britain next summer.

The same hard-line regime responsible for the Tiananmen Square massacre was firing live shells off Taiwan last month just as BT's and C&W's advisers were getting back around the negotiating table again.

China watchers say the Taiwan incident was a warning to the people of Hong Kong not to rock the boat with calls for independence ahead of the handover.

Turmoil, they add, is also likely to follow the death of China's ageing Premier, Deng Xiaoping. Either way, doing a deal with C&W substantially increases the political risk to BT in what would become easily its most important international market.

The situation in Europe is less fraught with danger, but just as confused. For the deal to go through, BT would have to spin off C&W's Mercury subsidiary to satisfy UK and European regulators. Speculation has been floated that Deutsche Telekom might buy the firm for about pounds 2bn in return for allowing BT to compete against it in Germany - Europe's largest national telecoms market.

BT already has telecom alliances with two utilities in Germany, while a third, Veba, owns 10 per cent of C&W.

Deutsche Telekom, however, already has an international alliance, Global One, with state-owned France Telecom and Sprint of the US, and last week its French partner quickly ruled out any interest in Mercury.

"We think it is enough for us to be present in this market through Global One," said Bruno Janet for France Telecom.

The assumption that Deutsche Telekom would welcome with open arms competition from BT - or any other operator for that matter - is clearly wide of the mark.

Only last week the European Union moved to block attempts by Deutsche Telekom to slash rates for corporate networks by up to 39 per cent after fledgling rivals complained the state-owned giant wanted to kill off the competition.

"You'll never get into Germany or France," says Adrian Ridley-Jones, managing consultant with London-based software and telecoms consultancy Logica.

Nevertheless, Logica forecasts that European telecoms monopolies could lose up to 40 per cent of their markets - and 70 per cent of their profits - in five years.

It is a glittering prize US telecoms giants, in particular, are keen to carry off. As the SBC/PacTel merger shows they are already limbering up to expand overseas in the wake of the US Telecommunications Act.

Executives of both US companies said the deal, the first between two Baby Bells, was driven by the need to create a company big enough to break into the international market. Two other regional phone companies - Bell Atlantic and Nynex Corp - have discussed a similar move, but talks are currently stalled on differences over price.

The key players for the moment, though, are likely to be the three aggressive, marketing-led forces in the US long-distance market: AT&T, Sprint and MCI (in which BT holds a 20 per cent stake).

AT&T, in particular, does not have a reputation for hanging about. It stole a march on the competition two years ago when its $12.6bn acquisition of McCaw catapulted it from nowhere to number one in cellular telephones. More recently it announced it was splitting itself into three, sharpening its focus by spinning off its equipment and computer units with the loss of 40,000 jobs. And the ink was barely dry on the Telecommunications Act before AT&T had filed applications in all 50 American states to offer local telephone services in competition to the Baby Bells.

AT&T has been a rumoured buyer of Mercury for some time. Indeed, it was C&W's preferred partner but baulked at the price demanded by Lord Young.

The group already has a domestic UK phone licence, but has so far limited itself to target revenues of $1bn a year in the UK by the year 2000, concentrating initially on the medium to large business sector.

BT's preference would be to float Mercury separately, or sell to financial buyers, to keep the likes of AT&T out of its back yard. Once on its own, though, Mercury would be fair game to a bidder.

Meanwhile, until the MCI deal, which covers the fast-growing market for offering voice, data and video services to multinational corporations, including management of their telecoms networks, BT's international record was not an enviable one.

Its search for overseas opportunities concentrated on north America but was largely fruitless and, in one particular instance, exceptionally costly. Buying Mitel, the Canadian telecoms equipment manufacturer, was a disaster. Taking a 22 per cent stake in McCaw, the largest mobile-phone operator in the US, was a better idea but BT was never able to obtain the management control it needed to make a go of the deal. In the end AT&T bought McCaw and bailed out BT, which was lucky to extract itself without a substantial loss.

Bringing BT and C&W together will do little to turn the transatlantic tide. While BT's alliance with MCI has increased its presence in the key north American market, getting into bed with C&W will do no such thing. Even the normally upbeat Lord Young was the first to admit that C&W had failed to make it in any serious way in the US.

Hong Kong, Europe and the US may be three good reasons why Britain's biggest ever merger may not be everything it is being cracked up to be. But perhaps the biggest question mark hangs over the enormous cultural differences that exist between the two groups.

"Strategically it is a very good move. It is the tactical digestion of the merger that will be the stumbling block," says Logica's Ridley-Jones. "I don't believe BT has the people to implement it."

"In cultural terms they are as different as chalk and cheese. C&W is more go-getting, more dynamic, more aggressive, more used to going into small countries in eastern Europe and winning business. BT is bureaucratic, a monopoly in nature if not in name. Its own internal structures and procedures are bad enough. How on earth is it going to sort out C&W?"

He believes it will take at least five years to address these issues, pointing out: "That's five years when BT will be looking inwardly not outwardly, when the telecoms marketplace will not be standing still."

Such siren voices, though, are unlikely to be heard this weekend in the boardrooms of the City's most prestigious institutions. More pressing matters are at hand, like carving up the estimated pounds 300m in fees in the most propitious way.