Analysts say MCI, Verizon isn't yet a done deal

Qwest could still be in the running, and probably won't just walk away from deal

The decision by MCI's board to accept the latest acquisition offer from Verizon doesn't mean the bidding battle between Verizon and Qwest Communications is over, analysts said Tuesday. While Verizon is generally seen by analysts as the more compatible suitor, Qwest shouldn't yet be counted out, they said.

"I don't think the fat lady has sung in this case," said Jay Pultz, research vice president at Gartner, in Stamford, Connecticut. "I think Verizon is closer now to being a winner, but the battle for control over MCI is not over as yet. ... It is not clear that they have completely won."

MCI announced on Tuesday that it has accepted an offer worth $7.6 billion from Verizon, rejecting a bid worth more than $8 billion from Qwest. Discussions between MCI and Verizon, and MCI and Qwest, have been going on for some time, constituting "one of the most ill-tempered episodes in recent U.S. telecom history," in the words of Ovum research director Jan Dawson, who is based in Boston.

Some observers expect Qwest to make another offer and others think that Qwest might even take its offer directly to shareholders, which could lead to a proxy fight. Qwest for its part had only this to say on Tuesday: "We respect the right of Verizon to change the composition and value of their bid, but we still believe our proposal creates superior value for shareowners. We are going to assess the situation and determine what is in the best interests of shareowners, customers and employees."

That Qwest seems to place shareholders first in the equation has not gone unnoticed.

"Qwest seems to be wooing MCI investors more than MCI executives," said Brian Washburn, a Newton, Massachusetts-based senior analyst at Current Analysis Inc. MCI employees may be worried that Qwest, which has a lot of debt, would spin off or sell MCI assets, Washburn and other analysts said.

Many MCI shareholders are hedge funds that bought MCI shares for a quick return, rather than necessarily for long-term investment, so they aren't as interested in long-range prospects, said Frank Dzubeck, president of consulting company Communications Network Architects Inc., in Washington, D.C.

Then there are the motivations of Qwest, which might want to keep bidding going as a way to pressure rival Verizon. "I'm sure they'd love to get MCI, but they may have had a pretty good idea from the outset that Verizon was going to get MCI, so why not make it more painful," Washburn said.

So far, though, Verizon has refused to get into much of a bidding battle. Although the offer accepted by MCI was an increase, it still is lower than Qwest's most recent offer, analysts noted. "I don't think it's a matter of price -- it's a strange situation," said independent telecoms analysts Jeff Kagan. "MCI would love to get a higher price, but Verizon hasn't bid it up. The bottom line is that MCI would rather go with Verizon."

While Kagan thinks that MCI could fit well with either suitor, the MCI board listed a number of factors in its decision to take the Verizon bid. It cited changing competition in the telecommunications industry; increased need for scale and comprehensive wireless capabilities; access economics; how well the companies will mesh; strength of the capital structure; ongoing ability to sustain network service quality and invest in new areas; and how best to ensure customer confidence among large business and government customers.

Ovum's Dawson listed similar arguments to support his belief that MCI and Verizon are a better pairing, but MCI's difficult recent history is also a factor, he said. "MCI is a company with a lot of trouble. Obviously, MCI has come a long way since it imploded a few years ago" and filed for bankruptcy, he said. The company continues to struggle financially, losing revenue as well as residential customers. It does, however, have substantial U.S. and global assets, with a strong business and government customer base, Dawson said.

The concern if MCI took the offer from Qwest, which also has financial problems, is that "they just kind of enter this downward spiral together and go into a tailspin," Dawson said.

After weeks of speculation about whether Verizon or Qwest would prevail, MCI on Feb. 14 accepted a $6.7 billion bid from Verizon. Three days later, Qwest increased its offer and deadlines were set to allow MCI to consider the rival bids and negotiate before the board made its decision.

MCI, formerly known WorldCom Inc., has faced financial struggles since June 2002, when an internal audit uncovered $3.8 billion in accounting errors. In July 2002, WorldCom declared bankruptcy, and the accounting misstatements eventually reached $11 billion. In March 2004, a month before the newly renamed MCI emerged from bankruptcy, the company issued a report reducing pretax income for 2000 and 2001 by $74.4 billion.

Before the company declared bankruptcy, WorldCom Chief Executive Officer Bernard Ebbers resigned in April 2002, amid questions about more than $360 million in personal loans he received from the company. In March 2004, Ebbers was charged in federal court in New York with conspiracy and securities fraud. Scott D. Sullivan, WorldCom's former chief financial officer, pleaded guilty and agreed to cooperate with prosecutors. Ebbers was recently convicted of the charges against him.

One unknown factor that would make a bigger difference to Verizon than to Qwest is MCI's carry-forward losses related to the financial shenanigans, Dzubeck said. It's likely that losses the company accrued while it was overstating its results, as well as during the period of bankruptcy that followed, could be applied against an acquirer's profits for a tax advantage, he said. Because Verizon, with its wireless cash cow, has tended to be more profitable than Qwest, those carry-forward losses could represent a very useful tax windfall, according to Dzubeck. However, the size of the carry-forward losses has not been made public.

Just as MCI has carried on despite ongoing turmoil in its recent history, the back-and-forth bidding saga "does not really have an immediate effect on customers," said Melanie Posey, research director at IDC. "It will take probably at least a year for any takeover to go through [regulatory] approvals and everything else. Nothing is going to happen in the short term that would change customers' experience."

The short term could well involve more bidding or even a proxy fight, she suggested. Given how aggressive Qwest has been, "I don't expect them to now just go away quietly," she said.

Joris Evers and Stephen Lawson in San Francisco and Grant Gross in Washington, D.C., contributed to this report.

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