EVENT FLASH

SBC To Acquire AT&T: The First Domino Falls

Melanie Posey, Courtney Munroe, Mark Winther, William Strofega

IN THIS EVENT FLASH

On January 31, 2005 SBC announced an agreement to acquire AT&T. A more in-depth analysis of the merger is forthcoming.

SITUATION OVERVIEW

The deal, valued at a total of $22 billion - $16 billion equity transaction, a $1 billion special dividend to AT&T shareholders, and the assumption of AT&T's $6 billion of net debt - is expected to close by the first half of 2006. The approvals required to conclude the transaction include AT&T's shareholders, the Department of Justice, the Federal Communications Commission, state regulatory authorities, and certain overseas regulators. AT&T's current market capitalization is just over $15 billion.

The expected transaction synergies will amount to more than $15 billion through 2009, with cost savings representing 85% of total synergies. Network operations and IT savings will account for the biggest chunk of cost savings, followed by business operations consolidation, and corporate overhead. Revenue synergies, estimated at only 10-15% of the total, are anticipated from new opportunities such as wireless sales to AT&T's enterprise customer base and VOIP and other IP services sales to small business and consumers. The deal includes a break-up fee of $560 million (3.5% of the transaction's total value).

FUTURE OUTLOOK

This deal, which will establish SBC as the largest U.S telecom operator, has a fundamental logic in bringing together AT&T's core strengths in the enterprise market (customers, offer portfolio, sales and service delivery sophistication), with SBC's scale and healthy financial profile. This logic is not new; the same rules applied when BellSouth and AT&T got very close to announcing a deal in 2003. Interesting, the purchase price floated for BellSouth acquisition was $6-7 billion higher than SBC is expected to pay. What is new is that the top executives Dave Dorman and Ed Whitacre know a lot more about each other and about telecom mergers. Dorman was head of PacBell when it agreed to be acquired by SBC.

SBC has spent a lot of time and capital over the past 2 years building a national enterprise data capability, and the AT&T acquisition boosts this process considerably. AT&T brings not only the all-important enterprise and government market customer relationships, but also the infrastructure required to serve this market - a national/global network, a broad portfolio of services and solutions, as well as sales and customer support personnel, processes, systems, and experience. In addition to its long distance network facilities, AT&T has local network facilities in 91 metro markets, expanding SBC's ability to serve enterprise customers outside of its 13-state local franchise area and improving upon its current out-of-region marketing push. Given that AT&T's systems and processes are superior to those of SBC, significant portions of SBC's enterprise market resources will be either unraveled or re-purposed to target the small and mid-sized business market. This means that a lot of the pain of synergies - understood as headcount cut-backs and duplicate systems eliminations – will be felt on the SBC side.

Yet the question remains whether SBC will be able to maintain AT&T's blue chip Fortune 1000 customer base and complex managed network solutions sales and delivery capabilities, while still realizing operational synergies through integrating AT&T into the SBC systems, process, and operations? Or will SBC be forced to gut AT&T to achieve target cost savings? Furthermore, the deal only addresses part of the enterprise market challenge. The combined SBC-AT&T will fight not only with Verizon, BellSouth, MCI, and other carriers but also IBM, EDS, and other IT-oriented service providers. Both SBC and AT&T have actively formed alliances with IT industry players (most recently, SBC's strategic alliance with HP), but the combination of SBC and AT&T does little to combat competitive threats from outside the telecom industry.

Will the historic reversal of the post-divestiture telecom landscape unleash an M&A feeding frenzy? Since receiving long distance approvals in late 2003, Verizon, SBC, BellSouth and Qwest have launched aggressive campaigns to capture a greater share of enterprise telecom spending. Both Verizon and SBC launched national data strategies to win in enterprise data networking, but SBC has been considerably more active than Verizon in building its nation IP network infrastructure and in developing a managed network services portfolio. BellSouth yearns to be a national player, but has so far resisted the urge to stray far from home. Qwest's financial position makes it an unlikely purchaser. With the SBC-AT&T combination, Verizon and BellSouth, the strongest of the remaining Bell companies, can no longer rely on organic growth to gain enterprise share-of-wallet, and IDC believes that SBC's move forces them into the M&A fray. This is good news for MCI, which is the only other company offering anything close to AT&T's strengths in enterprise networking. Before the end of March, IDC predicts and announcement of an MCI acquisition. The Sprint-Nextel entity, with more of a specialist wireless-wireline integration play on the enterprise side, may also prove a tempting target — particularly for BellSouth.

The regulatory picture remains unclear and could emerge as the deal's wildcard. While it is unlikely that the DOJ or the FCC will stand in the way of the deal, the regulatory approvals at the state level may prove more problematic (and of course, time-consuming). The merger must pass muster with more than 20 state commissions which will look closely at the merged entity's market share in select markets.

A big question for the success of this deal is this: on how many fronts can SBC fight its battles? IDC believes that this deal is primarily about the enterprise marketplace, but SBC must also compete in two other areas. In consumer, it must fight for broadband and triple-play against the cable companies. In wireless, the new Cingular will be fighting with Verizon Wireless and the combined Nextel-Sprint. The AT&T merger has little immediate effect on wireless, although the combined entity will leverage AT&T's enterprise customer base for additional wireless sales. If VOIP is the future, then the AT&T acquisition gives SBC a robust platform for both consumers and enterprise customers. From the consumer perspective, SBC gains a proven and battle hardened consumer VOIP product in AT&T's CallVantage. Furthermore, AT&T finally gains access to the last mile, which give the combined entity a leg up in competing with likes of virtual network operators such as Vonage. Also, SBC's wireless assets and its U-Verse initiative could make consumer VOIP more about convergence and less about making cheap hone calls. SBC's Enterprise VOIP offerings have been particularly successful and the company has managed to win several large enterprise VOIP contracts including a deal with Ford. AT&T's enterprise business and multinational reach will enable SBC to present a domestic and international product mix that the other Bell companies would hard pressed to match.

SBC has a lot on its plate in the near future: completion of the AT&T merger and the subsequent integration; the on-going integration of AT&T Wireless, the Project Light Speed fiber rollout, the IP TV initiative; movement on the recently announced strategic alliance with HP; as well as the task of making sure all the parts function in a cohesive manner. However, the combination of SBC and AT&T creates a considerably stronger, integrated telecom industry player, and SBC's healthy balance sheet, conservative accounting, and sheer size should comfort wary C-level enterprise decision-makers.


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