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WorldCom To Buy MFS

Event
WorldCom Inc., the U.S.'s fourth-largest provider of long-distance telephone service, announced on August 26 that it has reached an agreement to acquire MFS Communications Co. for over $55 a share, or about $14.4 billion in stock. The new company will be called MFS WorldCom Inc.

Analysis

Synergy
For the merger to make any economic sense it has to add value for pre-merger shareholders. Obviously, MFS shareholders are receiving additional shareholder value in the form of a premium, approximately 60% over their pre-merger stock price. Thus the question becomes, how can the merger create value greater than the compensation paid to MFS shareholders to make WorldCom shareholders better off?

The combined company will offer one-stop shopping for their corporate accounts. Under MFS WorldCom Inc., customers would be able to buy local, long-distance, data and Internet services from a single carrier. This can translate into two, not necessarily mutually exclusive, sources of additional revenue: increase demand for their services, and/or the emerging company might be able to charge a higher price than its competitor for the added convenience. Thus, there will be additional, or incremental, revenue due to the merger.

MFS offers business customers less expensive connections to long-distance networks, at about 15 percent discount over what local telephone companies charge.

Another potential source of synergy is combining operations, especially billing, thus, creating positive cash flows in terms of lower operating costs.

Sources of Competition
The Bells, meanwhile, are gearing up to sell long-distance services, something they have longed to do ever since their spin-off from the old AT&T. However, the Bells are at a disadvantage as they must meet a 14-point "checklist" showing that their markets are open to competition, a process which could take a year or more according to some analysts quoted by the Journal.. At the same time, the Bells are fighting regulatory battles in their home states.

WorldCom and MFS have none of those problems. Both carriers already have their own facilities in place, qualifying for preferential treatment under the new federal "interconnection" rules, according to the Journal.

On the same day, AT&T announced a deal to use the facilities of Teleport Communications Group, a cable-television owned company that provides business customers with direct links to long-distance companies in competition with the Bells. AT&T will use the MFS-like carrier in nine cities and is negotiating with Teleport to help it expand its local links to residences. Moreover, AT&T is rapidly becoming a major provider of consumer Internet services.

AT&T, MCI and Sprint are moving rapidly to offer packages of services to corporate customers. These long-distance carriers provide services to both business and residential customers. This could be an added advantage as the economies of scale work in favor of the large providers.

Meanwhile, AT&T, MCI and Sprint still face legal delays. They must wait until a community’s Bell company offers long-distance services before they can jointly market local and long-distance services.

Other Merger Targets
A number of companies might become prime target for further consolidation in the industry, including Teleport Communications Group, which is controlled by a group of cable companies, Brooks Fiber Properties, McLeod, ICG Communications, which operates Intelcom Group, GST Telecommunications and American Communications Services. Some analysts quoted by the Journal speculated that Teleport could be taken over by AT&T; others said the cable companies that control Teleport already have other joint-venture agreements with long-distance rival Sprint, fueling speculation that Sprint could bid for Teleport. Teleport's shares rose $1.375, to $25.625 on August 26.

David Sherry, co-manager of the GT Global Telecommunications Fund in San Francisco, told the Journal that he also considered two wireless companies as takeover candidates because they too offer or plan to offer local access, through digital radio communications rather than wires. These are Winstar Communications and Associated Group's unit Associated Communications, which AT&T President Alex Mandl just announced that he would leave AT&T to run.

Possible Counter Bid
The merger deal is expected to be completed in four to eight months, after regulatory and shareholder approvals. Meanwhile, there might be some other bids coming in.

But several analysts said they thought AT&T could have done even more with MFS than WorldCom will. This prompted Mr. Sherry, whose GT Global Telecommunications Fund holds MFS shares, to point out to the Journal the possibility that AT&T might try to outbid WorldCom.

Differences in Strategic Approaches: Build vs. Build Strategy
As noted above, MCI is also actively trying to build its one-stop-shopping for local, long-distance, and Internet access. However, it has followed a different strategy. MCI gradually built its local networks reaching about 45% of their business customers. Mr. Gerald Taylor, president of MCI Communications Corp. was quoted by the Journal as saying that it ‘ seems like [WorldCom is] spending $12 billion for the same thing we spent a billion on."

Market Reaction

WorldCom's stock price fell 14%, to $22.75, down $3.625, on the Nasdaq stock market after the acquisition was announced. This reduced the value of the transaction to about $12.4 billion, or $47.77 a share, from its initial value of $14.4 billion, or $55.38 a share, before the deal was announced. On the other hand, shares of MFS rose $9.94 a share to $44.81 on Nasdaq.

 Meanwhile, shares of other telecom companies took hits on August 26, perhaps in part because of expectations that a pumped-up WorldCom could create problems for rivals. Bell Atlantic fell to $57.25, down $1.25, while BellSouth slipped to $38, down 62.5 cents. Nynex, Pacific Telesis Group and SBC Communications also declined. AT&T Corp. changed hands at $53.625, down $1.

Financing
WorldCom is paying 2.1 shares of its stock for each MFS share, or about $55.38 based on WorldCom's closing price of $26.375. Based on MFS’s Friday close of $34.875, this is a premium of 59% for each MFS share. WorldCom will issue 500 million to 550 million shares to acquire MFS.

New Emerging Company
The combination of WorldCom and MFS creates the nation's first fully integrated local and long-distance phone company since the breakup of the Bell System in 1984. By combining networks they will be able to offer business and government customers a full complement of services: local and long-distance phone, data transmission and access to the Internet. These customers account for 40 percent of the total 100 billion local telephone market.

 The emerging company will have an annual revenue of $5.4 billion, growing 30% annually; over 500,000 business customers; and a combined market capitalization of more than $23 billion, operations in 45 domestic markets and 500,000 corporate customers, rivaling the sizes of numerous Baby Bell phone companies and bigger than MCI Communications Corp. Moreover, MFS WorldCom Inc. is expected to generate $700 million in revenue internationally.

 Other Telecom Mergers
Consolidation in the Telecommunication industry is heating up. In April, SBC Communications Inc., the San Antonio-based Baby Bell, set plans to buy San Francisco-based Pacific Telesis Group. With only several weeks separating their announcements, Bell Atlantic Corp. and Nynex Corp. said they, too, planned to merge.

 Some Background On WorldCom
Mr. Ebbers, WorldCom’s CEO, has built the Jackson, Miss., company mainly by purchasing dozens of smaller, well-run rivals, including Metromedia, WilTel and a host of smaller service resellers. From little more than $100 million in annual revenue in 1989, WorldCom's revenue grew to $3.6 billion last year and is expected to top $5 billion this year, especially after adding MFS. And this revenue comes from world-class long-distance services: Like AT&T, WorldCom provides communications links throughout the U.S. and to more than 200 countries. WorldCom also sells satellite transmission services through another recent acquisition, IDB Communications Group.

 MFS of Omaha, Neb., is the biggest competitor to the Bells. The company is expected to post about $1 billion in revenue this year from providing alternative local connections to businesses -- bypassing the Bell networks -- up from $583.2 million in 1995. Currently it services customers in 45 cities. MFS's assets have been almost doubling each year and its revenue has been climbing by 75% annually. Recently it moved into Internet services with a plan to buy pioneering UUNet Technologies Inc., a provider of high-speed Internet access services to businesses.

 Sources
WSJ, August 26, 27, 1996 & N.Y. Times, August 27, 1996, WashingtonPost.com, August 27, 1996.

By Alex Tajirian