Buyer beware: MCI WorldCom must watch its step as it attempts Sprint merger

Regulators will likely block the MCI WorldCom/Sprint merger or force Sprint to sell its Internet backbone business under close supervision.

It's hard to say how or when regulators will act on the proposed merger, the largest in telecom history. But observers say the deal to combine the No. 2 and No. 3 U.S. long-distance carriers is getting more scrutiny than WorldCom's $37 billion buyout of MCI in 1998.

"Regulators are beginning to fear industry oligopoly," said Brian Adamik, chief operating officer of The Yankee Group.

Six states have approved the merger, with 18 left. The Department of Justice, the FCC and the European Commission also are reviewing it.

The merged company that controls about one-third of the $105 billion long-distance market - second only to AT&T - and 45% or more of the $8 billion Internet backbone market (see table).

The DOJ might file a lawsuit to stop the merger, arguing that the merger could concentrate the long-distance and Internet-backbone markets enough to be anti-competitive, said Scott Cleland, an analyst at Legg Mason Precursor Group.

Spokesmen for MCI WorldCom and Sprint said they did not know whether their companies would fight the DOJ in court or forgo the merger if a suit is filed. "We're confident the merger will go through," said a Sprint spokesman.

But regulators might block the deal for several reasons, Cleland and others said. The FCC is wary of another merger between big interexchange carriers. The DOJ has hired a top-gun litigator to review the merger. And, most notably, the combined company could dominate the growing business of Internet backbones.

"The merger will result in anti-competitive network effects," AT&T said in filings with the FCC. "The merged entity's share of the Internet backbone market will allow it to raise rivals' costs and degrade the quality of their interconnections."

Another danger, critics said, is that customers could flock to the merged company's bigger, faster network, creating a barrier to entry for smaller providers. MCI WorldCom and Sprint, which run the UUNet and SprintLink backbones, deny they'd dominate the market. "The pie itself has gotten so much bigger, there's no way we could exercise market power," said an MCI WorldCom spokesman.

Regulators have faced this issue before. The DOJ, the FCC and the EC in 1998 required MCI to sell its Internet backbone arm to Cable & Wireless as a condition for approval of its merger with WorldCom.

A similar divestiture of Sprint's backbone is likely if regulators don't block the deal outright. MCI WorldCom CEO Bernard Ebbers has said he will not sell UUNet. Sprint has said it will sell its Internet business if necessary.

If Sprint sells, the company will have to avoid the disaster that followed MCI's sale of its Internet business to C&W for $1.75 billion. C&W sued MCI for breach of contract in federal court, alleging that MCI failed to transfer all of the staff, customers and back-end support it had promised. MCI paid C&W $200 million in a settlement announced March 1. Analysts estimate the company lost at least 20% of its backbone business.

The lesson is that Sprint must make a clean break by selling clearly defined assets and by spelling out each side's responsibilities. "The challenge is taking an integrated business and divesting it," said Art Medici, senior vice president of marketing for C&W.

A merger-related divestiture also needs proper, possibly governmental, oversight - something sorely lacking in MCI's sale to C&W, observers said. "The divesting company needs to regard the business as a complete business unto itself."

A divestiture won't fly because it's impossible to separate a company's backbone business from the rest of its telecom business, said some critics. To try to divide them is "fundamentally flawed," said Debbie Goldman, a research economist at the Communications Workers of America.