Analyst: MCI-Qwest combo may be damaging

As the industry awaits what many believe will be yet another larger bid for MCI by Qwest Communications, one leading management consulting company says an MCI-Qwest hookup would have sharply negative consequences for the telecom industry compared to an MCI-Verizon combination.

In a white paper available on its Web site, Eastern Management Group says combining Qwest with MCI will reduce competition, potentially damage the U.S. economy and put the Internet backbone at risk. A Verizon-MCI combo also would provide more balance in an industry that would otherwise be dwarfed by the merged SBC-AT&T operation.

The core issue, says author Robert Saunders, is that under CEO Richard Notebaert, Qwest has been focused on cost-cutting, not network investment.

"The expectation is that the classic Qwest network would be retired, because it is costing them so much money to maintain it, and the MCI network is making money," said Saunders, who based the White Paper on extensive interviews with public sources. "That means you are essentially removing a competitor from the marketplace. By contrast, Verizon will be adding on to their network. Wall Street is backing them as they made this commitment to invest this massive chunk of money in improving the network [by building fiber-to-the-premises]."

Saunders credits Notebaert with taking the draconian cost-cutting measures required to put Qwest right after he took over the reins from former CEO Joseph Nacchio.

"Under new stewardship, Qwest has managed to end the bankruptcy speculation, improve its bottom-line and slow the exodus of customers in the states where it operates as the dominant local exchange carrier, thus winning praise from the company's board and Wall Street," the White Paper states. "These successes, however, have come at a price: massive layoffs, radically reduced capital expenditure, and an almost total abandonment of next-generation broadband deployment."

Qwest has cut its capex by 80% since 2001, a much deeper cut than other former Bell companies.

Taking that philosophy forward in running a combined Qwest-MCI would cause a ripple effect that would be damaging to the industry overall because of the reduced capital investment, Saunders added.

"We are worried about capex--because that bleeds out into operations systems, the network equipment vendors and third party software vendors," he said.

That overall effect would be negative and the resulting job loss significant, the White Paper states. By contrast, Verizon is expected to use MCI's network to carry its long-distance traffic and to expand that business, Saunders said.

There is also a strong sense on Wall Street that Qwest is fighting hard to win the MCI bid because it risks "falling out of the peer group" of large telecom players, Saunders said. After months of talks between Qwest and MCI, the company initially lost out to Verizon but has come clawing back, pulling out all stops to be the winning bidder.

"Qwest needs a big deal, and they need it now, or they are going to fall out of the peer group," he said. "Their biggest problem right now is the lack of wireless assets--all of the others in the peer group have wireless assets."

The possibility of a Qwest-Sprint connection could still exist, but it isn't on the drawing board.

"Qwest is so focused on MCI--that's where all their bandwidth is going," he said. "It's hard to see what their backup plan is."

EMG's advice to Qwest is to focus on its local assets and work harder to push broadband deployment.