An Investment Opinion
The story goes like this: Last fall Qwest entered into a highly rancorous bidding war with Global Crossing (Nasdaq: GBLX) over Frontier Corporation and Baby Bell U S West (NYSE: USW). In the end, Global Crossing wound up merging with Frontier, while Qwest came away with an acquisition agreement with U S West. Many Qwest shareholders were critical of the merger because U S West, as an Incumbent Local Exchange Carrier (ILEC), has a much different economic model than the heretofore lithe Qwest broadband communications model.
However, the merger was approved by the shareholders of both companies. The deal is at this present time complete, save the necessary approval by the Public Utility Commissions of several of the states served by U S West. Until these requisite approvals are received, however, Qwest and U S West must operate as separate companies with their own management teams.
But Qwest's handling of U S West and other merger possibilities of late smacks of -- oh, OK, I'll say it -- arrogance.
You of course know the old saw about the grass being greener on the other side of the fence. It seems that Qwest's controlling shareholder caught this bug himself when he opened up discussion with Deutsche Telekom (NYSE: DT) about Qwest and U S West being acquired by the former monopoly carrier from Germany. There are two issues at stake here, a matter of appropriateness and one of timing.
Appropriateness first. It seems, from the press releases from U S West, that Qwest left them completely in the dark about its negotiations with Deutsche Telekom. Although Qwest and U S West have an agreement to merge, one that has been approved by both companies' shareholders, the deal is not yet complete. It requires, as noted earlier, significant regulatory approval from state PUC's, most of which are not yet forthcoming.
Further, Qwest, it seems, did not bother to appropriately inform U S West of its discussions with Deutsche Telekom. This matters, because what would essentially have to happen would be for Deutsche Telekom to make separate offers for Qwest and for U S West. If this were true, Qwest is negotiating on behalf of U S West without their permission or knowledge. As one should expect, once this rumor came out, U S West was not pleased and publicly demanded to know the status of the talks between Qwest and DT. This became so rancorous that the General Counsel for U S West sent an incendiary letter to Qwest claiming that they were in "clear violation of their merger agreement," and that U S West may sue not only for the $800 million breakup penalty but also punitive damages.
I'm a Qwest shareholder, but I've got to be on the side of U S West on this one. Qwest's share price has languished ever since it announced it's agreement to acquire U S West, so perhaps management has soured upon the deal. This would be a stunning reversal for U S West, since Qwest wanted it so badly late last year that it launched a bidding war to get it.
Not that I consider the threat of a lawsuit to be serious. But Qwest is muddying the well water in a big way, and U S West, which is still an independent company, has every right to make a stink about not being consulted. Among other reasons, the regulators looking at the original deal would not take kindly to having the potential for a foreign carrier taking control of a Baby Bell thrust upon them mid-stream. The new management team for Qwest/U S West would not include the current U S West CEO, and is likely going to be top-heavy with people from Qwest. Moreover, it's pretty clearly stated in the merger agreement between the two that neither may hold discussions with another outside company until their current merger is complete.
Of course, the possibility exists that U S West was in fact aware of the talks, gave its blessing to Qwest, but is now playing its card as the one that can scuttle the whole thing. Think about it this way: They have a deal with Qwest that does not allow for talks with another company. They are apprised of the interest from DT, let Qwest or a shareholder representative hold talks with DT, and then scream bloody murder that they are going to end up being the ugly stepsister in the deal. The fireworks from U S West could be nothing more than a ploy to maximize their bargaining position. If this is the case, then it doesn't make me feel much better, because it would mean that U S West completely gamed Qwest, making themselves out to be the victim. This brings me to the matter of timing.
Deutsche Telekom is currently partially owned by the German Government. This keeps DT off of the acquisition plate of other companies as the German Government wields enough votes to block a hostile takeover. This protection ends in June, when the remainder of the state held shares will be sold. DT has clearly been on the acquisition trail as of late, as it looks to consolidate its position as one of the major telecom players to make itself acquisition proof.
Qwest would make a great deal of sense for DT, as it would give the carrier a much-desired stake in the lucrative U.S. market. But DT is a carrier with market domination in Germany, and as such the regulatory hurdles it would have to clear, particularly to get U S West, are steep. But DT's timing problem is not Qwest's. Qwest would have been much better off to either complete its merger with U S West and then talk with DT (or another suitor -- it's not like DT is the only international carrier on the acquisition trail), or to be up front and break off it's merger with U S West. Instead, they've managed to make regulatory approval of the U S West deal much more difficult AND they've needlessly complicated a potential deal with DT, which, if done correctly, is a deal that would make a great deal of sense.
So now we've got a big mess, one where shareholders of none of the three companies know what's happening. So I'm going to make a prediction: DT will break off talks with Qwest. Too messy as they stand. Instead, DT will move to take over Cable & Wireless, PLC (NYSE: CWP), which has significant U.S. operations, a global fiber network, and some burgeoning strategic relationships with such Internet players as Pacific Century Cyberworks, the company that is going to buy C&W Hong Kong Tel (NYSE: HKT) and CMGi (Nasdaq: CMGI), with which C&W has agreed to a stock swap contingent on the PCC purchase of HKT.
Got all that? That's what has me bothered. Qwest could make this deal, but they've sure nailed one of their own feet to the floor in the process.
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