Regulators May Require Spinoffs Before Okaying AT&T-SBC Merger

SBC’s merger with AT&T undoubtedly will require some divestitures, analysts and others predicted Mon. as the companies announced the $16 billion transaction. SBC Chmn. Edward Whitacre told the news media he didn’t expect regulators to order spinoffs but others say such action may be inevitable, with reviews expected by state regulators, the FCC, the Dept. of Justice and possibly international regulatory bodies. The merger will eventually gain antitrust and regulatory clearance “but could be subject to significant divestitures, particularly in SBC’s region,” Legg Mason predicted in a report Mon. Regulatory attorney Andrew Lipman said there’s a “high probability” of regulators requiring “spinoffs and surgery.”

Whitacre told reporters he didn’t expect any divestitures would be needed because: “If you look, there is a lot of competition across the telecommunications industry now that it’s changed a great deal over the last few years. There is wireless, there’s cable companies, there’s CLECs, there’s telephone companies. There is a huge amount of competition and I wouldn’t think any divestitures would be required.”

Asked why the deal wasn’t expected to close until the first half of 2006, Whitacre said: “We have to go and seek approval in 26 to 28 states and those commissions, and certainly we hope it won’t take long. We also have to have approval of Justice Department and the FCC. Procedurally, it just takes a while. We'd hope it could be done quicker and not later and we just have to see how that goes on.” Meanwhile, Whitacre said SBC and AT&T would have to “sort out” whether they can start working together before receiving regulatory approvals.

Sens. DeWine (R-O.) and Kohl (D-Wis.), chmn. and ranking Democrat of the Senate Judiciary Antitrust Subcommittee, said the deal would need to be scrutinized “very carefully” and announced they would hold a hearing on the merger. “The proposed merger between SBC and AT&T will create the nation’s largest telecommunications company and go a long way towards re-creating the old Ma Bell system. It will remove an important competitor in both national and local service for thousands of American businesses and millions of consumers. And perhaps more important, this merger takes place in an industry already witnessing the decline of independent local phone competition, and rapid consolidation in the wireless sector,” they said in a joint statement.

The FCC will begin its review once the companies submit an application for the licenses changes required by the divestiture, officials there said. Such applications usually aren’t submitted for several weeks, perhaps a month and that probably will be the case for SBC, several sources said. Two types of licenses will be at issue: (1) Wireless licenses, which in this case will include AT&T’s microwave licenses used in providing long distance service plus fairly routine licenses used by all business, for example, radios used to communicate with trucks. (2) More significant Sec. 214 licenses which trigger the public interest standard used by the FCC to weigh mergers. Once the application is filed, the FCC will issue a public notice, which triggers a 180-day clock. In past merger reviews, the clock frequently has been halted.

Lipman said there are 3 areas divestitures might be required: (1) The consumer business where AT&T remains SBC’s main competitor even though AT&T is planning to exit the UNE platform business for new customers. (2) AT&T fiber links acquired in a merger many years ago with Teleport that compete with SBC facilities in the Bell’s region. (3) Enterprise customers in SBC’s territory. “SBC will argue that their enterprise take-up is light but when you look under a magnifying glass it seems there are some high concentrations,” Lipman said.

Legg Mason analysts said they expected divestiture of AT&T’s small business and consumer operations in SBC’s region would be a key requirement for merger approval. However, Legg Mason said, the enterprise part of the business also may raise difficulties “because of SBC’s increased service to large business customers.” Overall, government review will focus on the loss of in-region competition “and state attorneys general and regulatory commissions in SBC’s territory could have significant concerns and clout,” Legg Mason said: “States in particular are likely to be sensitive to whether sales of divested operations are being made to viable entities, a concern that may also resonate at the DoJ.”

Although Whitacre said the companies will have to seek approvals from at least 26 states in addition to the required federal approvals. But regulators in some of those states say they don’t know yet just how extensive a review will be required, since SBC will be the surviving company and AT&T generally is considered one among many competitive carriers. A Cal. PUC spokesman said the PUC will conduct a review of the merger, but the scale and scope of that docket has yet to be determined. An Ohio PUC spokesman said the agency will look at the merger, but “we need to talk to the companies before determining what our review will entail.” The Ill. Commerce Commission was looking into its jurisdiction regarding this merger. A spokesman for the Tex. PUC said the agency wasn’t required to review this merger. But he said if a 3rd party petitioned for review on grounds the deal is anticompetitive, the PUC could elect to conduct a review. SBC and AT&T both were still looking at which states will require full-scale hearings and which ones could follow simpler procedures.

Progress & Freedom Foundation Pres. Ray Gifford predicted the regulatory analysis would focus on horizontal rather than vertical competitive issues. This would once have been considered a vertical merger for SBC into the long distance market “but that market is rapidly disappearing,” said Gifford, a former state regulator.

Legg Mason’s report also noted the merger would diminish or eliminate AT&T’s lobbying presence in Washington, which would be felt during the expected rewrite of the Telecom Act. Several telecom veterans in Washington seconded that comment. “Oh my, yes,” said one. “AT&T bankrolls many competitive initiatives” in Washington and this means the competitive industry will have to “fend for itself now.”

Merger Would Create Largest Communications Company

SBC said the merger would create the nation’s largest communications company. The transaction would combine AT&T’s global systems capabilities, business and govt. customers and IP-based business with SBC’s local exchange, broadband and wireless solutions. SBC said the deal would give it “immediate global leadership in the enterprise segment” and access to advanced national and global networks. “Today’s agreement is a huge step forward in our efforts to build a company that will lead an American communications revolution in the 21st century,” Whitacre said.

Under the agreement approved by the companies’ boards over the weekend, SBC’s Whitacre would remain chmn., while AT&T CEO David Dorman would take one of 3 seats AT&T would have on the combined company’s board and become president. AT&T shareholders would receive total consideration currently valued at $19.71 per share, or about $16 billion. They would receive 0.77942 shares of SBC common stock for each common share of AT&T. At closing, AT&T would pay its shareholders a special dividend of $1.30 per share. The stock consideration in the transaction is expected to be tax-free to AT&T shareholders. The combined company would be based at SBC’s hq in San Antonio.

The AT&T brand will remain, Whitacre told reporters: “AT&T is a terrific brand… It’s not going away.” He said the companies had yet to figure out how the brand would be used. “We value the heritage and strength of the AT&T brand, which is one of the most widely recognized and respected names throughout the world, and it will certainly be a part of the new company’s future,” he said in a statement.

The companies haven’t decided how many jobs to eliminate in the merger. “It’s really too soon to tell, but the merger is an opportunity to consolidate operations and… for redundant jobs to be eliminated,” an SBC spokeswoman said. She said the companies would “do some operational reviews” over the next year to determine how many positions should be cut. Both SBC and AT&T have announced expected 2005 workforce reductions, but SBC executives have indicated there would be job additions in some growing areas of the company.

Legg Mason said with AT&T already going through aggressive headcount reduction, “gaining significant synergies from further reductions may prove challenging, especially with the retention of key sales personnel required to retain the corporate customers that are behind the SBC’s desire to own AT&T.”

CWA, which represents 15,000 AT&T and 95,000 SBC employees, supported the merger and urged regulators to approve it. The union said it was concerned about “the employment security and career opportunity” of the companies’ employees. It said the deal would make “good business sense,” because it would create “a strong U.S. competitor in the global telecom marketplace with the resources to substantially advance the rollout of high- speed broadband and other services and drive economic growth and job expansion.” That would benefit employees as well as customers and shareholders of both companies, it said. The union, has criticized AT&T for contracting its business and cutting jobs.

SBC and AT&T have “highly complementary” assets, the companies said. They said AT&T would bring to the table an advanced communications network to meet the data communications needs of large businesses with multiple locations. Dorman said AT&T serves virtually every member of the Fortune 1000 global companies and has operations in more than 50 countries. SBC said it would also benefit from AT&T’s “broad, high-end enterprise customer base, proven sales expertise in complex communications solutions, and an advanced product portfolio including a broad range of IP-based services.”

SBC and AT&T said they expected the deal to generate $15 billion in synergies, which they said “ramp quickly with a net annual run rate of $2 billion or greater beginning in 2008.” They said nearly half the synergies would come from network operations and IT, as facilities and operations were consolidated. SBC said it expected the acquisition would slow its revenue growth rate in the near term following closing. But it said it expected the deal to be cash-flow positive in 2007 and earnings per share positive in 2008, with both growing in the years thereafter. It said new revenue sources would include expanded wireless sales to larger businesses, and taking AT&T’s portfolio of enterprise IP-based services down- market to small business and residential customers. SBC also said it expected free cash-flow after dividends to let it reduce combined debt over the next 5 years. AT&T has about $6 billion in net debt and SBC $26 billion.

Dorman said AT&T was still waiting for the FCC to release final UNE rules: “With respect to transitioning, our expectation is that our platform as a regulatory matter will go away after a year and we have had negotiations across the local exchange industry for a UNE- P replacement.” Dorman said AT&T had “a fairly large UNE base” outside the SBC region, and “that’s something that as a wholesale customer we hope to have the opportunity to do where it makes sense.”

Consumer groups strongly opposed the merger, calling it “very troubling.” “It demonstrates the complete failure of policy to promote competition in the marketplace and would mark one of the final acts in the long running reconsolidation of the industry,” said Consumers Union Senior Dir.-Public Policy Gene Kimmelman. He said it was time for Congress to “reconsider the deregulation experiment of the 1996 Act and give consumers the protection that market forces are failing to provide.” Consumer Federation of America Research Dir. Mark Cooper expressed concern that the deal could mean less competition and higher prices for consumers. He said consumers had only 2 choices -- a single cable company dominating video and high- speed Internet, and a Bell company dominating local, long distance and wireless. “Two companies are not enough to provide serious price competition or strong incentives to innovate,” he said: “The Bells and cable companies have become fixated with putting together large bundles of services that only the richest Americans can afford.”

Cable Competition Helped Spur Deal

Increasing cable competition helped spur the deal, Whitacre said: “The cable companies are becoming more and more of a competitor to SBC, they are taking share from us with their VoIP products… And certainly it was an input for this transaction.”

Cable companies have targeted VoIP as a major growth area for the next year and are aggressively investing in adding customers and services. The prospect of dealing with a stronger and bigger competitor just as cable gets a foothold in voice products raised some concern for the industry. NCTA Pres. Robert Sachs issued a statement Mon. reflecting the nervousness: “The proposed combination of the largest and second largest telephone providers in SBC’s 13- state region raises obvious antitrust concerns that regulatory authorities will have to scrutinize carefully.”

Whitacre said AT&T’s VoIP business was “one of the appealing parts” of the deal: “I'd anticipate, of course, that will save us a lot of money, time, effort and development costs. I would hope we could certainly roll it into what they [AT&T] have because it’s a top product.” SBC has “a lot of business IP customers,” but doesn’t expect to start rolling out residential VoIP until mid- Feb., he said. AT&T Chmn. David Dorman stressed that VoIP was “a global product… that expands your thinking about VoIP” beyond “SBC’s 13 state territory.” Asked whether VoIP would get SBC into the rest of the country, Whitacre said: “We certainly would have that capability.”

Reaction on Capitol Hill Mixed

Rep. Boucher (D-Va.) praised the merger as “very appropriate.” Boucher, a member of both the House Commerce and Judiciary committees, said the merger wouldn’t diminish competition in any significant way and doubted that the House Judiciary Committee would hold a hearing on it. He said antitrust regulators -- either the Justice Dept. or the FTC -- should approve the merger. “I can’t imagine substantial objections being raised,” he said. Boucher said there would still be plenty of competition for SBC, much of it coming from the emerging VoIP technology. “It’s coming extraordinarily quickly,” Boucher said. VoIP will eventually let the Bells compete against each other outside their markets, he said.

On AT&T, Boucher said the company is “a mere shadow of its former self.” “There’s a tremendous amount of competition in long distance,” he said. “The market has grown away from AT&T. It was eventually going to be acquired by someone.” Boucher noted that most of AT&T’s value now resides in its brand name and its fiber-optic network.

Aside from Boucher and the Senate Judiciary subcommittee, it’s unclear how the merger would be received by the rest of Capitol Hill. No other members made statements at our deadlines, and one industry source couldn’t even speculate how Senate Commerce Committee Chmn. Stevens (R-Alaska) would react. Stevens is generally thought to have a favorable opinion of AT&T, which has several properties in Alaska. And while some wondered how the merger would affect lobbying on the upcoming telecom act rewrite legislation, one House source said the bill could be done on the House side before the merger is formally approved.