Convergence /

Analyst: Justice preparing to block MCI WorldCom/Sprint deal

Regulators see past spinoff of MCI's Internet business to Cable & Wireless as a bad precedent.

By David Rohde
Network World, 03/15/00

MCI WorldCom and Sprint this morning are reeling from a report by a prominent analyst that says the Department of Justice will block the two carriers' proposed merger.

Scott Cleland, lead analyst for the Legg Mason Precursor Group, said that the Justice Department is preparing to request an injunction against the merger in federal court. MCI WorldCom and Sprint would then have the right to seek a trial, but Cleland noted that few mergers held up in this manner ever go through.

In his report, Cleland repeatedly cited what he called the "failure" of the 1998 spinoff of the former MCI Internet backbone to Cable & Wireless - the key move that sealed government approval of the merger between MCI and WorldCom.

The current MCI WorldCom has broadly signaled that it would be willing this time to spin off Sprint's Internet business, but Cleland says the Justice Department doesn't think that's nearly enough. In a harsh assessment, Cleland says the Justice Department is "embarrassed that the MCI divestiture to Cable & Wireless went so badly," and added that the regulators "harbor a 'fool me once, shame on you, fool me twice, shame on me' attitude towards MCI WorldCom."

Cable & Wireless last year sued MCI WorldCom, charging among other things that the MCI Internet customer records they received were fouled up. Cable & Wireless customers themselves also complained that the transition was rocky. The two companies recently settled the case, with MCI WorldCom agreeing to pay $200 million.

MCI WorldCom did not admit to any wrongdoing, but Cleland says the settlement "strongly suggests that that Cable & Wireless' charges of competitive damage from anticompetitive conduct had merit."

Among other reasons that the merger is in trouble, according to Cleland:

The Justice Department has signed on top litigation attorneys for the case, something it has rarely done in past telecom mergers.

The Justice Department doesn't buy into theories that regional Bell operating companies will soon be entering the long-distance market in many states.

The next-biggest competitor, Qwest, will soon be shut out of long-distance service in 14 states because of its pending merger with US West, which is barred from long-distance carriage in its own territory.

The combination of MCI WorldCom and Sprint not only increases concentration in the long-distance voice market, but also in frame relay and ATM.

Cleland cautioned that the Justice Department's action may not come immediately and may even take several months. He did go on to say that if MCI WorldCom can't buy Sprint, someone else probably will. Likely prospects include BellSouth and Deutsche Telekom.

Other analysts were rushing this morning to put their own spin on the report, in what appeared to be a largely successful effort to avoid damage to Sprint's stock. A.G. Edwards sent out a note disagreeing with Cleland's analysis, but adding that even if the merger is blocked, Sprint's value should hold up as an acquisition target for someone else.

MCI WorldCom and a Sprint spokesman said the companies remain confident that the merger will be approved and closed in the second half of 2000. The Sprint spokesman added that his company is taking care to identify its Internet customer and network assets so there is no confusion in case of a spinoff.

After an initial slide, Sprint's stock at midmorning stood at 57 9/16, down 1/8. MCI WorldCom was actually up 3/16 at 43 1/4, most likely reflecting the flip side of investor reaction that normally pushes down an acquiring company's stock.