MCI still hopes to complete Verizon deal, but will scrutinize retooled Qwest offer

By Paul Deckelman

New York, Feb. 25 - MCI Inc. still wants to merge with Verizon Communications Inc. as planned. But the Ashburn, Va.-based long-distance carrier, apparently bowing to the reality that Verizon is not the only would-be buyer - and that at least some of its shareholders want to see it accept a higher cash and stock offer from Qwest Communications International Inc. - said Friday that it would fulfill its fiduciary responsibilities to its shareholders to get the best deal for them and carefully weigh Qwest's retooled buyout offer.

"We acknowledge receipt of Qwest's proposals, and remain respectful of all parties," MCI's president and chief executive officer, Michael D. Capellas, said on the company's conference call following the release of its 2004 fourth-quarter and full-year results.

However, demonstrating that it will still take an awful lot to get MCI's board to change its mind, back out of the Verizon deal and link up with Qwest, Capellas had just moments before on the call reiterated why MCI had accepted Verizon's offer, even though it was smaller than Qwest's earlier offer, let alone its now-improved bid.

"Our board concluded that this [Verizon] is the right partner," he asserted. "We will do our utmost to complete the transaction."

New York-based Verizon and Denver-based Qwest, both of them regional Bell operating companies that provide local telephone service to most customers in their respective territories, the Northeast and the Midwest-Rocky Mountain states, each want MCI in order to get the latter's national telecommunications network, its roster of corporate and especially government customers, and the prodigious revenues and cash flows that have allowed MCI to amass a cash hoard of over $5 billion.

Verizon and Qwest each turned their sights on MCI after yet another RBOC, San Antonio, Tex.-based SBC Communications Inc., which serves the Southwest and parts of the Midwest, announced plans to acquire traditional long-distance leader AT&T Corp. for $16 billion, creating a company that would be the largest telecom industry player, revenue-wise.

Qwest was the first would-be MCI acquirer to show up in news reports in early February, after having reportedly made an informal offer to MCI valued at about $6.3 billion of cash and stock. However, as MCI and Verizon senior executives said during their Valentines' Day conference call announcing the planned engagement of their respective companies, MCI and Verizon had been talking for many months about getting together before finally agreeing on a cash and stock deal valued at the time at $6.746 billion, or $20.75 per MCI share. The Verizon offer consisted of $4.795 billion of Verizon stock, or $14.75 per share, to be given to MCI shareholders in a ratio of 0.4062 shares of Verizon common stock for each MCI common share; $488 million of up-front cash or $1.50 per share; and the remaining $1.463 billion in MCI cash, payable to the MCI shareholders in the form of special dividends worth $4.50 per share.

Qwest - which had reportedly upped its bid for MCI to the $7.2 to $7.3 billion area the weekend before the official MCI-Verizon announcement - refused to concede defeat, saying it would keep its options open. Qwest chief executive officer Richard Notebaert complained that MCI had not even given his company the courtesy of officially meeting with Qwest to sound it out on its bid and give his company an opportunity to make its case for a merger.

And Qwest revealed the details of its spurned offer, which it estimated was worth some $8 billion, or $23 per MCI share - far more than the $7.3 billion figure bandied about the media. The improved offer consisted of $7.50 a share in cash and $15.50 of Qwest common stock, based on a fixed exchange ratio of 3.735 Qwest shares per MCI share. The revised Qwest plan also included guarantees that MCI would continue to pay its stakeholders $508 million in special dividends worth $1.60 a share, a continuation of the current dividend plan, bringing the total worth of the bid to $24.60 per MCI share.

Even that revelation, and Notebaert's statement on his own earnings conference call, the day after the MCI-Verizon announcement, that MCI had "left over $1 billion of cash on the table" by agreeing to the lower offer, failed to budge MCI's board from its endorsement of the Verizon deal. Some MCI shareholders, however, expressed dismay that the company had accepted the clearly lower offer, or, at the least that it had accepted Verizon's bid so quickly, without trying to use Qwest to wring better terms out of Verizon.

Industry observers said MCI management was probably swayed by Verizon's considerably stronger financial status than the debt-ridden Qwest, believing that it would have much easier access to the financing needed for the deal.

More cash in new Qwest bid

Undaunted, Qwest said it would make a revised offer for MCI, and sure enough, it did, announcing in a letter to MCI on Thursday afternoon that it was prepared to offer revised terms. Although the total amount of the Quest offer to MCI remains the same, at $24.60 per share, Qwest is now offering more up-front cash, changing the schedule of cash payments to MCI shareholders from four quarterly dividends of 40 cents apiece and a closing payment of $7.50 to a $6 per share one-time payment upon shareholder approval of the merger and a closing payment of $3.10 a share.

Besides tinkering with the cash payment schedule, the revised Qwest bid also includes a collar that will keep the stock portion of the offer at $15.50 per MCI share, even if the price of Qwest stock falls below $4.15 per share - the assumed price used to set the initial offer - by providing for more Qwest shares in that case.

By way of contrast, the Verizon offer contains no such collar, and its offer is now estimated to be worth only $6.64 million - $100 million less than it was on Feb. 14 - because Verizon stock has fallen in the interim.

Analyst questions choice

One analyst on the call - while saying that MCI management had so far done "a very fine job" in representing company shareholders, asked point-blank: "What has to happen for you folks to be legally able to sit down with Qwest and to figure out whose is the best offer?"

He added that it seemed to him that "the market is telling you it's not happy" with MCI's summary rejection so far of the clearly larger offer, for whatever the reason.

MCI's general counsel Stacy Kelly, answered that "we've acknowledged Qwest's offer. Our board, which is a model of corporate governance, will thoroughly review and analyze Qwest's revised proposal, just as it did the prior proposal."

She said that she could give no indication of how long this might take because "the board will take the time it needs to analyze and review the proposal, and to take the appropriate next step."

She said that the board would be guided by both "our obligations under the merger agreement" - which includes a $200 million break-up fee payable to Verizon should MCI get cold feet and decide to back out - "and the board's fiduciary obligations to shareholders."

Capellas, asked by an analyst whether he thought the Verizon deal has sufficient support among MCI shareholders, said that "we will do our utmost to drive that [deal] through, that's our responsibility," but he declined to specify what level of support he thought it had.

"We're comfortable [with the Verizon deal], you've heard my comments what the benefits of the transaction are. Obviously, we entered into it, so we believe in it, and we'll do our utmost" to get the deal completed. At the same time, he said, "we'll just continue to honor our fiduciary responsibilities."

No balance sheet actions for now

In answer to other merger-related questions, MCI's chief financial officer, Robert Blakely, said that the company would wait until after the shareholder vote on the merger deal to decide what it wants to do about entering into any transactions aimed at restructuring the company's balance sheet, which as of Dec. 31, 2004, included the $5.7 billion of junk bond debt MCI incurred in April 2004 as it made the transition from its former incarnation as the scandal-plagued WorldCom Inc., and some $268 million of capitalized leases.

"We need a little more certainty" before acting, he said.

Restrictions on dividends

Blakely also said that the maximum amount of the company's cash that could be "dividended out" to the shareholders as part of any merger agreement - and both Qwest and, especially, Verizon have included MCI-paid dividends as part of their respective offers to the shareholders - was $2.3 billion, that is, excess cash of $2.2 billion plus an additional $100 million, based on the current structure of the indentures governing its three series of bonds.

The CFO said this could change - in theory - but "you basically have to have cumulative net income, and it will be quite a while in the foreseeable future, before we would have more room under the indenture," given the $3.5 billion of pre-tax impairment charges the company took in relation to its full-year results.

MCI reported a fourth-quarter net loss $32 million (10 cents per basic and diluted share) - an improvement over the net loss of $3.4 billion it posted in the third quarter of 2004, which included the huge impairment charge. It had net income of $22.2 billion in the fourth quarter of 2003, reflecting the financial impact of reorganization activities. Revenues in the fourth quarter were $5 billion, a decline of 2% sequentially and 10% year-over-year.

Operating income for the 2004 fourth quarter was $434 million, compared to an operating loss of $3.4 billion (or operating income of $121 million excluding pre-tax impairment charges of $3.5 billion) in the third quarter, and an operating loss of $332 million in the fourth quarter of 2003.

For the full year 2004, revenues totaled $20.7 billion, down 15% percent from 2003 revenues of $24.3 billion. The operating loss was $3.2 billion. Operating income, before $1.9 billion of depreciation and amortization, a $1 million gain on property dispositions and $3.5 billion of impairment charges, would have been $2.2 billion in 2004. In 2003, operating income was $700 million; operating income before $2.3 billion of depreciation and amortization, and a $43 million loss on property dispositions would have been $3.0 billion.

The company had cash, cash equivalents and marketable securities of $5.5 billion at year-end, down from $5.6 billion as of the end of the third quarter on Sept. 30, 2004 due to MCI having paid $167 million in bankruptcy claims, invested $332 million in property plant and equipment, and disbursed $127 million as a return of capital dividend.

Blakely noted that MCI had made the first interest payment, in November, of about $200 million on its new notes, and said that the company was projecting total 2005 interest expense on the bonds of $440 million, reflecting the 100-basis point increase in the interest rates on the three series of notes that took effect Dec. 15, after they were assigned initial credit ratings by Moody's Investors' Service and Standard and Poor's, which triggered a reset of their coupons.

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