WorldCom/Sprint merger on life support

Prior divestiture hampering efforts to get Sprint deal approved - on both sides of the Atlantic

Talk of assets, market share and potential divestitures dominated public debate about the proposed WorldCom/Sprint merger, but it was lack of trust between regulators and WorldCom officials that undermined any hope of the deal surviving antitrust scrutiny, according to those close to the negotiations.

Last week, the Department of Justice filed suit to block the $129 billion merger, while the European Commission nixed the deal the following day. Both bodies indicated a WorldCom/Sprint union would be anticompetitive and bad for consumers, although their points of emphasis were different.

European officials' lone point of contention was the potential for a merged WorldCom/Sprint to dominate Internet access. U.S. antitrust officials said a merger combining the country's second- and third-largest long-distance carriers would limit consumers' long-distance choices because together with AT&T, a merged WorldCom/Sprint would control 80% of the long-distance market.

"If WorldCom were allowed to acquire Sprint, large and small businesses and millions of individual consumers would have to pay higher prices and accept lower service quality and less innovation," said Joel Klein, assistant attorney general for the DOJ's antitrust division.

Neither argument was surprising. To allay fears of Internet domination, the companies agreed to divest Sprint's Internet backbone.

The companies contended that no long-distance divestiture should be required, citing the U.S. market's numerous competitors, RBOCs qualifying to offer long-distance and technological improvements that allow cheap - or free - voice calls over lines traditionally used to transport data.

But the companies recently indicated they were willing to divest all of Sprint's long-distance holdings - the component presenting the least long-term growth - to complete the deal, according to multiple reports. Such a divestiture would reduce the immediate cost savings promised by the merger, but most observers believe it would be worthwhile to ensure that WorldCom could fill its wireless void with Sprint's powerful PCS package.

Yet these concessions were not enough to satisfy regulators on either side of the Atlantic. In both the U.S. and Europe, regulators demanded concessions that left WorldCom and Sprint officials scratching their heads and, in one case, in no mood to negotiate.

While WorldCom agreed not to increase its Internet holdings in the deal, European regulators wanted the merged company to divest a portion of UUNet instead of selling Sprint's backbone.

"Who's ever heard of requiring the acquiring company to give up one of its assets to make a deal work?" asked one industry observer close to the negotiations.

An additional concession sought by the DOJ was more surprising. Largely overlooked in the proposed mega-deal is Sprint's more than 8 million local lines in 18 states. This was not expected to be an issue in the merger because WorldCom was not a local carrier.

But the DOJ insisted Sprint's local holdings be divested to approve the deal, Sprint said.

"When [DOJ officials] said that, [WorldCom and Sprint representatives] walked out of the room," said another industry observer close to the negotiations.

As to the logic behind the unusual concession requests, some point to European concerns about a U.S.-dominated Internet, while others note the heavy lobbying efforts of competitors such as AT&T and the RBOCs. But more telling may have been regulators' perception of WorldCom's divestiture of assets as part of its merger agreement with MCI.

That deal was contingent upon the divestiture of MCI's Internet backbone. WorldCom sold its Internet holdings to Cable & Wireless in 1998 for $1.75 billion, but the British-based service provider later filed suit in March 1999, claiming WorldCom failed to supply key personnel and customer information. Mike McTighe, C&W CEO of global operations, told the Senate Commerce Committee last November that some of the problems C&W faced were because of the close integration of MCI's Internet business with its other businesses.

With WorldCom proposing a similar divestiture of Sprint's Internet backbone, this episode left regulators with serious doubts about whether WorldCom would divest assets in a manner that would allow a potential buyer to realize their previous value.

Ultimately, this lack of trust may be the undoing of the WorldCom/Sprint deal. In general, regulators are more wary of divestitures in large mergers, said Stephen Kamman, telecom analyst for CIBC World Markets. But the remedies proposed by regulators in this case indicate that they remembered the C&W Internet problems, he said.

"I think the perception's out there, and I don't think it helped," Kamman said. "The Europeans were particularly angered [by the divestiture to C&W]."

"This merger was over the line from the beginning," said Scott Cleland, analyst for The Precursor Group, citing the argument that three competitors in an industry typically are needed for a deal to pass antitrust muster. "Complicating that fact was that MCI WorldCom did not live up to its end of the bargain last time," he said. "When you want to bend the rules - and you've bent the rules before and been caught - the enforcement agency is going to stop you."