Execs Explain SBC, AT&T Pairing

Light Reading
News Analysis
Light Reading
1/31/2005



SBC Communications Inc. (NYSE: SBC) and AT&T Corp. (NYSE: T) today made it official: The two carriers will merge in a deal valued at around $16 billion. Senior executives from both companies say the merger will create a ”prototype for 21st century telecom companies.” (See SBC to Buy AT&T for $16B.) The deal represents a huge and much-needed consolidation for carriers, and analysts say it will lead to similar moves by competing carriers (see SBC/AT&T Could Ignite M&A Frenzy and SBC/AT&T: Possible Winners & Losers).

While the two companies have explored the possibility of pairing up over the years, AT&T chairman and CEO Dave Dorman says his company saw the merger as an opportunity to accelerate its growth and transformation by pairing with SBC. “With our step back from the consumer market to focus on enterprise services, AT&T is a very complementary partner for SBC,” he said in a morning conference call. “It’s a hand-in-glove partnership.”

But others have a different view. Given AT&T's troubles of late, many see the deal signaling that AT&T knew it doesn’t have the cards to compete and decided to fold before the pot got too big. Indeed, the terms of the deal do not give AT&T investors a premium price. “On its own, AT&T had a much more challenging future,” says Legg Mason Inc. telecom analyst Brad Wilson. “The benefit for AT&T investors from this deal is that they have a future.”

The deal will indeed have a major financial impact on both the companies, although investors will have to wait until 2008 to see the combined carrier turn a profit. The combined company predicts it will be free cashflow positive in 2007 and earnings per share (EPS) positive in 2008. SBC says the duo will have an annual revenue run rate of almost $2 billion in 2008, growing to more than $3 billion by 2011.

AT&T's shares fell $0.59 (2.99%) to $19.12 in late afternoon trading on Monday. SBC's shares went the other way; they rose $0.11 (0.47%) to $23.73.

The companies say that their complementary networks will provide a solid foundation for integrated services that includes a global IP backbone, local access, broadband access, and a nationwide wireless network (see SBC/AT&T Cheat Sheet).

But there will be some overlap as well. The companies plan to combine all aspects of their businesses, which will lead to some layoffs and facility combinations. The two carriers say their network centers, local switches, and field sales forces will be combined. There will also be consolidation around network planning and engineering functions. However, no immediate layoff estimates were given by the companies.

”The thing that jumps out at me about this deal is the amount of cost savings that will take place across the board,” says Stan Hubbard, senior analyst at Heavy Reading. “They’re predicting $15 billion in savings through cost reductions and revenue growth.” Hubbard notes that the companies expect 85 percent of the synergies to come from cost reductions by eliminating duplicate facilities and streamlining business processes and organizations.

The pairing will also give AT&T an opportunity to get some major traffic on its IP network. “They’re finally going to have an opportunity to put a lot of traffic on their intelligent network,” Hubbard says. Hubbard says that’s bad news for WilTel Communications Group Inc., the carrier currently providing SBC's IP services.

AT&T’s CallVantage VOIP offering is another ripe fruit that fits in well with SBC’s Project Lightspeed, which aims to offer video and voice services to 18 million customers by 2007 (see SBC Sheds Light on 'Lightspeed'). SBC chairman and CEO Edward Whitacre says that AT&T’s VOIP offering was an appealing part of the deal. “We hope we can roll our existing VOIP programs into what they have as quickly as possible,” he says. Such a move is a big win for SBC, whose VOIP offering is scheduled to roll out to consumers next month.

“What this does is accelerate our ability to migrate to IP in the local platform,” says SBC COO Randall Stephenson. “In terms of Lightspeed, this is probably one of the most exciting parts about this deal. Obviously when you start moving video and high-speed data by the volumes we’re talking about in deploying Lightspeed, the kind of backbone capacity that AT&T brings to bear is really exciting.”

An AT&T/SBC pairing is anything but a done deal, as the companies must get regulatory approval from the Antitrust Division of the U.S. Department of Justice, the Federal Communications Commission (FCC), and as many as 28 states. “I think there is a good chance this deal gets done,” says Heavy Reading’s Hubbard. “Part of it depends on who will be the new FCC chairman and how market-friendly he or she is." (See Chairman Powell to Step Down.)

Legg Mason’s Wilson also believes the merger will happen, but says it might take longer than the 17 months the companies estimate. “It’s probably more likely to take 18 months,” he says. “The key issue is how bad the states involved muck up the process.” He also thinks AT&T might have to divest some of its small business operations before the deal gets approval.

SBC’s Whitacre says the AT&T name will stick around in some capacity, possibly as the company’s business arm. “AT&T is an American icon,” he says, "and we plan on allowing it to continue as we move forward. Some may think it’s ironic that a Baby Bell is acquiring its parent, but it’s the right move. It’s good for shareholders, customers, and employees.”

One issue still to be resolved has to do with SBC’s investment in Cingular Wireless, which it holds in partnership with BellSouth Corp. (NYSE: BLS). Many observers see this as a major conflict brewing, but SBC downplayed those concerns with folksy reassurances in lieu of real proof. "This deal will be real good for Cingular,” Whitacre says. “This is the best deal at this time. I don't think that the relationship [with BellSouth] will be soured."

Looking ahead, the combined SBC/AT&T intends to focus on increasing revenues through higher-growth segments like VOIP, IP VPN, Ethernet, and network management. By acquiring AT&T, SBC will gain enterprise expertise and AT&T’s nationwide network, which will allow it to expand its enterprise base and eliminate costs. “Our local and global assets complement each other,” says AT&T’s Dorman. “Companies who invest in all local or long-haul access don’t take into consideration what consumers want.”

“In terms of size, this deal is not the largest I’ve been involved with,” Whitacre adds. “But it certainly is the most important for the future of the telecommunications industry.”

— Chris Somerville, Senior Editor, Next-Generation Services

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