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M&A players: British Telecom and MCI Communications Value: $20 billion Announced: November 3 Investment bankers: Lazard Brothers, NM Rothschild, Morgan Stanley British Telecom has publicized its proposed merger with MCI Communications of the US as an exercise in lowering overheads and increasing global reach. But large numbers of shareholders may not wish to wait for the benefits to come through. A wave of post-merger selling is expected, especially from former MCI shareholders who have no interest in owning a foreign utility they consider only a rung up from a nationalized industry. The new company Concert will not appear in US indices, such as the S&P 500, giving US institutions another reason not to hold the stock. The prospect of a US shareholder backlash was what made MCI’s investment banker Lazard Brothers push for a share buyback of up to 10%, something BT through its advisors NM Rothschild & Sons wanted to avoid. It was the major sticking point in intense negotiations between the companies that almost came to grief on several occasions. The other key issues were a dividend payment to BT shareholders that MCI shareholders will not receive; and the size of the cash portion of the offer made for MCI stock. BT is offering 5.4 of its own shares plus $6 in cash for each MCI share. Says an investment banker in New York: “One of the critical elements of any deal which had to be mostly a stock deal because of the size of it was that it had to take account of a fair amount of shifting among the shareholder base of the companies. There needed to be enough buyer support from BT after the merger to rebuild the shareholder base. Many US institutions would want to get out and a significant buyback after the merger was a sine qua non.” BT thought a buyback wasn’t necessary and that the cash component of the bid was a sufficient reward for MCI stockholders. On this aspect of the bid MCI won out. BT’s relationship with MCI goes back to June 1993 when it announced plans to invest $4.3 billion for a 20% stake in MCI, a deal that was firmed up the following March. Later in 1994 joint global services were launched under the name Concert. Then, in the summer of this year, senior executives of both companies BT’s chairman Sir Iain Vallance; its chief executive, Sir Peter Bonfield; MCI’s chairman and CEO Bert Roberts and its president and chief operating officer Gerald Taylor began serious discussions on the advantages of a full merger. Further deregulation of the $100 billion US telecoms market will allow MCI, a long-distance carrier, to compete there while a more integrated European market will provide further opportunities. By combining their strengths, the companies would be better able to exploit these and other markets, calculated their senior executives. With this end in mind, BT and MCI instructed their investment bank advisers to negotiate a merger. While the companies clearly know each other well, conducting negotiations through third parties was vitally important that way, if the deal fell apart, working relationships would not be jeopardized. As well as Lazard and Rotshchild, Morgan Stanley was hired by BT to advise on reactions to the deal among shareholders. From the viewpoint of MCI shareholders, the aim was to get the best possible price for their stock but not one so high it destroyed the value of the Concert paper they would end up holding. “We had to get the right value for our shareholders but not so much value that the quality of the paper was undermined,” says John Nelson, vice-chairman of Lazard Brothers in London. “If you had a deal that diluted the value of BT paper, you would be doing a deal against yourself.” The final offer price valued MCI at $39 a share (at the prevailing exchange and share prices following the deal’s announcement in early November), and meant that BT would end up paying $20 billion in shares and cash for the final 80% of MCI. The $6 cash per share will result in a total cash payment of £2.3 billion ($3.8 billion) if the merger, which is subject to US regulatory approval, goes through. This is similar in value to the £2.2 billion that will be paid as a special dividend to BT stockholders regardless of whether the deal goes ahead or not. While investment bankers insist this is a coincidence, analysts argue that the companies are offering sweeteners to shareholders to ensure the deal’s completion. “The discretionary share buyback and the special dividend are sweeteners to shareholders and are sufficient compensation for near-term earnings dilution,” says Paul Norris, European telecoms analyst with Lehman Brothers. “We are extremely positive on the deal from an industry perspective. We think Concert will turn out as one global mean machine.” The determination of senior executives not to have their plans derailed is shown by the poison pill of $450 million that either company cancelling the deal must pay to the other. This is to prevent another suitor coming in and spoiling the agreement. The special dividend will also shore up the value of BT paper as the currency of the deal. But while management is gung-ho, the challenge for bankers has been to keep investors in two very different stocks happy as bedfellows. MCI is a growth stock with high gearing and low dividends of just five cents a share last year. BT, by contrast, is a conservative company with net debt equal to 8% of equity and paying out high dividends. Will the resulting Concert with 65% gearing satisfy anybody or nobody? The likelihood of dissent among US shareholders led to the creation of the buyback facility, but will UK shareholders be any happier? Given the enlarged position that Concert will hold in UK indices, some UK institutions will be obliged to buy for the same reason their US colleagues will sell. But with their special dividends in hand and the prospect of future dividends below earnings growth, many shareholders may decide to quit. As well as building global networks, Concert may have to spend time rebuilding its shareholder base. |
