Consolidation in the USA: does bigger mean better?

Citation

Curwen, P. (2005), "Consolidation in the USA: does bigger mean better?", info, Vol. 7 No. 5. https://doi.org/10.1108/info.2005.27207eab.001

Consolidation in the USA: does bigger mean better?

Consolidation in the USA: does bigger mean better?

A regular column on the information industries

Jack Welch, the former CEO of General Motors, was fond of the maxim that unless you are number one or two in an industry, you are dead. If he is right, then GM, for one, is not long in this world, at least as a manufacturer of cars, and if that sounds implausible then one has only to consider the decline of the former “world’s largest company”, US Steel, or the fate of AT&T, discussed below. All were certainly very big, but that, of itself, was not the direct cause of their eventual decline. They failed because they became bureaucratic and unresponsive to opportunities and trends in the marketplace that were pounced on by smaller and nimbler rivals. Hence, it is fair to say that bigger does not necessarily mean worse – after all, AT&T initially became bigger by being better – but in the longer term bigness tends to have its downside in companies where management and “the vision thing” are not of the highest quality.

It is of no small interest, accordingly, to reflect upon the current rush towards consolidation in the US telecommunications sector. Ever since the market collapse at the turn of the decade which put paid to any prospects formergers and acquistions (M&A) activity, the consensus view has been that without consolidation the structure of the sector would remain insufficiently unprofitable. But, even assuming that all of the current M&A activity is successful, does that imply that the resultant, much bigger, companies will demonstrate that “the whole is greater than the sum of its parts” and hence that profitability will improve?

One does not need to look very far to discover that the converse may prove to be true. At the end of 1999, AOL was worth $170 billion although this figure was somewhat difficult to justify on the basis of revenues or profitability. It then offered to buy Time Warner, creating a company, AOL Time Warner, potentially worth $327 billion at the time of the bid. By the time the bid had received the official blessing of the relevant agencies nearly half of that value had disappeared, yet much worse was to come. Indeed, in October 2003, the name AOL was dropped and the company henceforth became known as Time Warner (Curwen and Whalley, 2004, Ch. 9). The fact that the takeover created an enormous amount of “goodwill” (the difference between the market value of the target prior to, and that subsequent on, the bid) is not of itself particularly remarkable, but the subsequent write-downs ($100 billion in 2002 alone) and the removal of the bidder’s name in favour of that of the target, certainly gives pause for thought. It goes almost without saying that whereas the benefits to be derived from the union of AOL and Time Warner were tangible and, in principle, convertible into financial projections, the union largely fell apart because of the intangible issue of bringing together fundamentally different corporate cultures.

In very recent times there has been much consolidation activity in the USA. It is fair to say that each announcement has spurred on other attempts to seek unions as the prospects of ending up as the smallest bridesmaid at the altar have focussed the minds of management, not to mention investment banks desperate for the good old days to return.

The trigger was the bidding war for AT&T Wireless, at the beginning of 2004, between the Vodafone Group and Cingular Wireless (jointly owned by Baby Bells SBC Communications and BellSouth). Initial interest had allegedly also been shown by Nextel and NTT DoCoMo, but they had been rapidly shut out. The initial offers were in the region of $30 billion, but by the time Vodafone withdrew in mid-February the cost had risen to $41 billion in cash. In effect, SBC and BellSouth were becoming increasingly dependent on their mobile operations and wanted to become as large as Verizon Wireless – post-merger Cingular would have 47.6 million customers less any forced divestitures compared to 40 million for Verizon Wireless. The acquisition was finalised at the end of October with few divestitures being required.

In mid-December 2004, it was revealed that Sprint and Nextel were negotiating a deal that would create a company worth some $70 billion with nearly 40 million subscribers, thereby creating the third-largest operator after Verizon and Cingular. Supposedly a merger of equals, the proposal nevertheless involved Sprint buying Nextel in a deal worth $36 billion and its shareholders ending up with a slight majority off the new company’s shares. Looked at objectively, the proposal gave cause for concern on several fronts. First, the companies used different mobile technologies for 2G, so the question was whether Nextel would need to switch from its proprietary technology and what would happen when proceeding to 3G. Second, there were numerous footprint overlaps that would probably lead to enforced disposals by regulators. Third, and, in the light of the above, perhaps most vexing, the management styles were significantly different, and with both companies of equal size the potential for culture clashes was substantial.

In the aftermath of the proposed Sprint-Nextel link-up, it was noted that Verizon Communications was considering a spoiling bid for Sprint, although it could not make a move without the support of wireless partner Vodafone. The fact that this would have created much the largest operator in the USA was highly problematic given the regulatory risk, even in a climate relatively favourable to consolidation, and whereas Verizon did indeed launch a spoiling bid, it was not, in the event for Sprint.

Rather, in mid-February 2005, Verizon Communications agreed to acquire MCI for roughly $6.6 billion in cash and paper. At the time, MCI – which, interestingly had also dropped the name of its previous parent, Worldcom, when emerging from Chapter 11 bankruptcy in 2003 (Curwen and Whalley, 2004, Ch. 7) – was the second-largest long-distance carrier in the USA with 14 million residential customers and one million corporate customers including many multinationals. That MCI accepted the offer was somewhat surprising since a higher offer, worth $7.3 billion, had previously been tabled by Qwest Communications, a telco that, unlike the other Baby Bells, owned a nationwide fibre-optic network as well as local operations in 14 states, but MCI argued that the Qwest bid was suspect because, inter alia, it was heavily indebted, its long-distance network was loss-making and it had relatively few corporate customers. For Verizon, serving mostly small and mid-sized companies, the purchase of MCI would provide a relatively cheap and easy way to expand its corporate business despite the investment that would be needed to upgrade and integrate its networks and the fact that Verizon would become exposed to the shrinking long-distance market. The Qwest offer was raised to $8.45 billion in cash, paper and dividends plus a “collar” to protect against future reductions in the Qwest share price, but this was again rejected in late March even though the market price was somewhat higher than that still on the table from Verizon.

Meanwhile, with the AT&T Wireless brand already set to be subsumed within Cingular, that of AT&T itself also looked increasingly likely to disappear. In July 2001, AT&T had sold AT&T Broadband to Comcast for $48 billion including debt taken on, and with AT&T Wireless hived off it represented little more than a rump long-distance operator. In March 2004, AT&T was dropped from the Dow Jones Index, and in October, it took a non-cash impairment charge of $11.4 billion to cover its decision to stop marketing traditional consumer telephone services and stated that it would be reducing its headcount by 20 per cent during 2004. Although it effectively had a “for sale” sign hanging over its head, this had given a fillip to its share price so it was thought to be too costly to attract a suitor. Nevertheless, one duly appeared in January 2005 in the guise of SBC Communications. The dowry amounted to $16 billion in SBC paper. This came as something of a surprise since there would almost certainly be regulatory problems and tensions would be inevitable between SBC and BellSouth (which had itself attempted to buy AT&T in 2003). Seven years previously, the FCC chairman had branded the idea of a Baby Bell acquiring its parent as unthinkable, but it seemed probable that this time around the parent would be allowed to be devoured by its offspring.

A final element in the consolidation process is the takeover bid, worth $4.4 billion plus $1.5 billion of debt taken on, by Alltel for fellow mobile operator Western Wireless in January 2005. One interesting effect of all of the above is that with consolidation taking place all around, T-Mobile has been left out of the game. However, it is unlikely to do anything about it as parent Deutsche Telekom is keen to hold on to it and the only other European operator involved, Vodafone, is itself left holding on to a minority stake in an albeit now to be enlarged operator using a technology that it uses nowhere else in the world.

Conclusions

At the time of writing there is still some way to go before all of the M&A activity outlined above comes to fruition, but with the Bush administration back in the White House and a new chairman appointed at the FCC who is unlikely to oppose restructuring, it is reasonable to expect every bid to succeed subject to qualifications. This does not merely unwind most of the supposedly pro-competitive restructuring imposed when AT&T was broken up, but actually see that behemoth effectively disappear even if its various brands live on.

At the time of the AT&T judgement it was broadly accepted that unless AT&T was broken up, its sheer size would protect it from ever falling by the roadside. It is impossible to test that hypothesis retrospectively, and, as yet at least, there is no organisation set to emerge from the above restructuring with AT&T’s former market power. Hence, whether we have seen the end of the restructuring process in the USA is a moot point, as is, indeed, whether the much enlarged organisations currently emerging will actually prove to be better than the sum of their parts. The structural wheel is spinning, but at least, prior to its division, AT&T had a common corporate culture. This is not true of the companies presently being merged, although there are no divisions on the heroic scale of AOL Time Warner, so all may go well even if promised synergies will be, as usual, much more difficult to realise than to promise. When it comes to justifying M&A activity, the claim that bigness leads to synergies and cost savings is an inevitability, but what will posterity have to say, one wonders, even in five years’ time about the surge of consolidation currently sweeping across the USA.

Peter CurwenVisiting Professor of Telecommunications, Strathclyde Business School, Glasgow, UK. E-mail: pjcurwen@hotmail.com