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Ma Bell Tries to Get Back on Track
by Jim Surowiecki (Surowiecki)

NEW YORK, NY (June 13, 1997) - Three years ago, futurist guru John Naisbitt published a book called Global Paradox, in which he argued that as the world's economy became bigger and more interconnected, smaller companies would -- paradoxically -- become more powerful. If recent developments in corporate America are any indication, though, very few CEOs accept Naisbitt's argument. Instead, size is increasingly seen as a key to dominance. Bigger, it seems, is better.

The latest, and perhaps most striking, indication of this trend toward agglomeration was the news that long-distance giant AT&T (NYSE: T) has been pursuing merger talks with SBC COMMUNICATIONS (NYSE: SBC), one of the Baby Bells created after the 1984 court-ordered breakup of, yes, AT&T. The $50 billion-plus merger would be the largest in history, and would create a company dominant in long-distance, wireless, and regional local service. It would also, of course, raise serious antitrust concerns, particularly given the still almost complete absence of real competition in local markets.

Ironically, SBC's discussions with AT&T followed immediately upon the completion of its $16.5 billion purchase of Pacific Telesis, an acquisition that gave SBC -- formerly known as Southwestern Bell -- control of one-third of the nation's phone lines and made it the country's second largest Baby Bell. Coupled with the recently-approved merger of NYNEX (NYSE: NYN) and BELL ATLANTIC (NYSE: BEL), SBC's maneuvers seem to point to an almost inevitable reality, which is a telecommunications landscape dominated by four or five giant companies, rather than dotted with many different fierce competitors. It's enough to make one wonder what the point of the AT&T breakup was.

The point was, of course, competition, and the lower prices and greater efficiencies that were meant to result from it. And certainly long-distance customers have reaped enormous gains from the opening of that market to companies like MCI (Nasdaq: MCIC) and SPRINT (NYSE: FON). Long-distance rates have dropped by 75% since 1984, and AT&T's bottom line has shown the effects.

Local customers, on the other hand, have seen their rates hardly budge at all. For most of us, the death of Ma Bell simply replaced one local monopoly with another. While last year's supposedly landmark Telecommunications Act sought to make local markets into competitive cauldrons, the reality has been tepid at best. Ninety-eight percent of all phone users get their local service from the dominant carrier in their area.

That reality has made the Baby Bells, on the whole, good investments, since they have been able to move into long-distance and wireless services without having to beat off any real threats to their core business. Still, the most successful of the post-breakup companies have been those, unsurprisingly, that have continued to push the envelope at home and abroad. Most notable among these has been SBC. Over the last seven years the company has acquired a 10% stake in Telmex, Mexico's state-dominated phone company. It moved powerfully into wireless, so that today a remarkably large percentage of its customers are cellular customers. And its acquisition of Pacific Telesis -- just completed on April 1 -- made clear the enormous scope of its ambitions. More than one analyst has called SBC the best-run Baby Bell in the country, and the company's consistent profit increases have helped its stock double in the last five years.

Perhaps the best evidence of SBC's strength is that it's far from clear which company would run things should the merger with AT&T go through. While AT&T is more than twice as large as SBC, and while AT&T clearly has the experience in long-distance service that SBC needs, by almost any measure the smaller company is the better-managed and more focused firm. While AT&T chairman Robert Allen has floundered and become a favorite target of critics of corporate mismanagement, SBC chief executive officer Ed Whitacre has earned a reputation as a daring and forceful manager who's enormously strong on execution -- exactly the place where AT&T has fallen down most recently. Even though John Walter was only recently installed as president and chief operating officer of the long-distance titan, it seems likely that he would be odd man out after a merger.

All of this assumes, of course, that a merger is a real possibility, and while it seems clear that Allen would love to leave AT&T with this feather in his cap -- he's scheduled to retire in 1998 -- what's not clear is whether the deal could gain federal approval. Although the FCC's approval of the NYNEX/Bell Atlantic deal surprised many, and convinced some critics that antitrust law had become a dead letter, the scope of an AT&T/SBC union would be such that serious scrutiny would be unavoidable. In addition to the simple question of size, the deal would bring together companies with overlapping businesses, companies that -- according to the ideals of the Telecommunications Act -- are putative competitors. For much of the West, in fact, the deal might very well mean a return to the days before 1984. And while consumers generally express a preference for having one company handle both long distance and local service, it's not clear that they would do so if it meant that prices would be substantially higher.

Both AT&T and SBC insist, of course, that the threat of competition will be enough to keep them from monopoly pricing, but clearly for AT&T at least part of the point of the merger will be to avoid the corrosive competition that has eaten into its profits over the last decade. A stronger line of defense against antitrust charges will be what one might call the anti-Naisbitt argument, namely that America needs a phone company large enough to compete globally against Deutsche Telekom, Nippon Telephone and Telegraph and British Telecommunications, which is in the process of acquiring MCI.

The distinction between global and local markets has become an important one in the 1990s, and seems to have been at the heart of the FTC's approval of the merger of BOEING (NYSE: BA) and McDONNELL DOUGLAS (NYSE: MD) and its veto of the deal between STAPLES (Nasdaq: SPLS) and OFFICE DEPOT (NYSE: ODP). While the argument for global competitiveness is often a plausible one, in the case of AT&T and SBC it rests on shaky foundations. The market for telecommunications is not fundamentally similar to the market for aircraft, and the major impact of the AT&T/SBC deal will be at home and not abroad. More to the point, it is AT&T's move into local service, not its acquisition of another long-distance company, that's at stake here, and the idea that local phone service has a global dimension seems dubious at best.

On the other hand, FCC chairman Reed Hundt stepped down just two weeks ago, and in the next few months four of the commission's five members will be replaced. That means that any AT&T/SBC deal will have the good fortune to come before a panel just beginning to carve out an identity for itself, which may make it less likely to take a strong antitrust stand. Of course, if the panel's composition shifts in a more regulatory direction, the merger is likely to be voted down.

For the moment, though, all of this remains speculative, since the talks between the two companies remain under wraps. Certainly the news that negotiations are underway has helped AT&T, encouraging investors who have been waiting for the firm to do something to jump-start its lackluster performance. The talks have also drawn considerable attention to SBC's continued success. Even if the merger were to fall through, SBC's prospects for the future look impressive. At least some of the Baby Bells, it seems clear, aren't babies anymore.

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