DEUTSCHE TELEKOM PULLS BID: Can Qwest, U S West repair the rift?

Qwest Communications, U S West and Deutsche Telekom gave shareholders a stomach-churning ride last week as contradictory rumors flew about a possible takeover deal of Qwest by No. 1 European carrier Deutsche Telekom. The ride ended with the European carrier terminating talks with Qwest after merger partner U S West objected.

U S West said it would not consider any deal that would delay the merger with Qwest or reduce the premium shareholders were expecting from that transaction. In a prepared statement that reflected the strain the rumored talks have put on U S West's and Qwest's relationship, Qwest chairman and CEO Joseph Nacchio said, "We regret that U S West apparently wouldn't even consider an alternative transaction involving a major telecommunications company and Qwest, despite the possibility of greater value for U S West shareholders."

The saga has become another black mark in Deutsche Telekom's history of trying to become a global mega-carrier. In the past year, the German company has been party to the demise of the Global One joint venture and a failing "white knight" bid for Telecom Italia, which it lost to Olivetti in February 1999.

Last week, it seemed that U S West was the company in danger of being left out. The carrier even threatened to sue Qwest if it tried to back out of its pending $50 billion purchase of U S West. But Qwest issued a statement that it was continuing with the merger approval process and that U S West would be part of any new agreement.

On Friday, the Qwest/U S West merger won FCC approval, subject to a planned divestiture of some long-distance customers. The deal still is under review by several states in U S West's 14-state region.

Widespread media reports indicated that Deutsche Telekom, the shy suitor hungry for Qwest's 25,500-mile North American fiber optic network, would make separate offers to the companies.

It would have been "brilliant" of Deutsche Telekom to offer to buy the companies separately, said Judy Reed Smith, CEO of Atlantic ACM, because Deutsche Telekom then could have fast-tracked the Qwest acquisition and dealt with the regulatory hurdles of buying a U.S. incumbent separately. Qwest and U S West stockholders would have had to approve such a deal.

"I can't see any reason why [Qwest] stockholders would not approve a dissolution of the [U S West] merger," she said, citing the beating that Qwest's share price has taken since the U S West deal was announced. Any move by Qwest to independently scuttle the U S West deal could result in more than $80 billion in breakup fees, so analysts say such a move is unlikely.

Qwest's North American long-distance network fits with Deutsche Telekom's global strategy, for which a foothold in the U.S. is a prerequisite. "Qwest makes good sense for Deutsche Telekom," said Nancy Bedard, an analyst at The Yankee Group. "But when you throw U S West into the picture, it's just an add-on. It's a local, legacy network, and it's not Deutsche Telekom's ambition to provide local services."

U S West's outgoing chairman, Sol Trujillo, battled his company's legacy perception at a conference last week, citing U S West's progress in building a customer base in DSL, integrated messaging and next generation cable. The company also has 2 million miles of fiber deployed in the U.S. Qwest and U S West "could offer bandwidth from the street corner to around the world - combining local touch with global reach," Trujillo said.

But Deutsche Telekom's withdrawn bid might make matters worse. While Trujillo has denied any rift, Nacchio's frustration with the long regulatory approval process and U S West's spotty history with regulators was evident two weeks ago. Nacchio told The Denver Post, "I want the [U S West] merger to go through, but I'm not going to get blackmailed to do dumb business things to make it go through."

The merger was announced on July 18, 1999, and approved by U S West shareholders on Nov. 2, 1999. But the state commissions' blessing in U S West's territory has come slowly, partly due to the RBOC's reputation for poor customer service. Last week, in an effort to win over the Washington Utilities and Transportation Commission, Qwest and U S West announced a proposal to freeze local phone rates until 2004 and subject the company to significant penalties if it doesn't meet certain quality standards. That came after Washington state's Attorney General's office recommended in February that the merger be denied unless the companies consented to conditions.

On the global front, Deutsche Telekom still is on the prowl and could be getting desperate. It has substantial cash reserves, but the competitive relief it enjoys from being majority owned by the government expires in June, Smith said. "There's still Global Crossing, BellSouth and Level 3," Smith said, speaking of other potential targets. However, their stocks are not as cheap as Qwest's, she said.