MCI, Qwest In Advanced Discussions
Analysts Question Suitability of Merger

By Yuki Noguchi and Ben White
Washington Post Staff Writers
Friday, February 4, 2005; Page E01

Qwest Communications International Inc. is in advanced discussions to buy MCI Inc., even as MCI pursues potential alternative deals with companies such as Verizon Communications Inc. and BellSouth Corp., said sources close to the negotiations.

The talks remain fluid as Ashburn-based MCI seeks to make the best deal it can as soon as it can, said the sources, who spoke on condition of anonymity while the private talks continue. Qwest's offer, the sources said, is for about $6.4 billion in stock, equal to MCI's market value.

MCI has been actively seeking a buyer for a year, the sources said. But the prospect of a merger has taken on new urgency since this week's announcement that SBC Communications Inc. plans to buy long-distance giant AT&T Corp. for
$16 billion.

A Qwest-MCI deal could be reached as early as Monday, said a Wall Street source close to the talks. Spokespeople for MCI, Qwest, Verizon and BellSouth declined comment. After the Wall Street Journal reported the MCI-Quest talks yesterday, MCI's shares rose 47 cents, or 2.4 percent, to close at $20.15. Qwest shares rose 20 cents, or 4.8 percent, to close at $4.40.

Many analysts and industry insiders greeted the potential merger with skepticism. They said putting MCI and Qwest together wouldn't necessarily produce a strong competitor able to take on a merged SBC and AT&T.

"From a long-term strategy, it doesn't make sense," said Muayyad Al-Chalabi, an analyst with South San Francisco-based research firm RHK Inc. Qwest is the weakest financially and strategically among the regional phone companies, he said.

"The question is, when you put them together, do you get something better or something worse?"

Neither Qwest nor MCI owns a wireless network. Cellular service is the prime generator of growth for companies such as Sprint, SBC and Verizon.

MCI's most valuable asset is its base of business customers, which requires a network that can transport voice and Internet traffic in and around big cities. But Qwest's local phone network doesn't connect to many of those areas, reducing the opportunity to cut network costs. Denver-based Qwest's 14-state network spans mostly rural states such as Arizona, New Mexico, Utah, North Dakota, South Dakota and Colorado, with its biggest markets in Seattle, Denver, Minneapolis and Phoenix.

Both companies have been saddled with accounting scandals in recent years.
MCI, formerly WorldCom Inc., completed a $11 billion financial restatement last year, and former chief executive Bernard J. Ebbers is on trial, charged with fraud and falsifying documents. Qwest paid $250 million in a settlement with the Securities and Exchange Commission late last year, the Justice Department is investigating the company, and the SEC is investigating several former Qwest executives.
There is no redeeming justification for this" merger, said Raul Katz, president and chief executive of Adventis Corp., a management consulting firm.

He said that leaking information about the talks could be part of an MCI strategy to solicit bids from potential partners such as Verizon or BellSouth. Both companies are in stronger financial shape than Qwest and have telecommunications empires that extend into technologies such as wireless and high-speed Internet access.

Still, some analysts said a Qwest-MCI deal could make sense as a marriage of two companies with limited options.

Qwest, which has a declining local and long-distance business, would benefit from MCI's corporate customers, which it could serve through its own, newer network, said Susan Kalla, an analyst with Friedman, Billings, Ramsey & Co.
For Qwest, MCI also could be a source of cash.

"It's an audacious move, but it would clear up Qwest's terrible balance sheet," said Andrew D. Lipman, vice chairman and lead telecommunications lawyer at Swidler Berlin LLP in Washington. Qwest has $17 billion in debt and $1.8 billion in cash. It has not had cash to invest in upgrades such as fiber-optic cable for the home, as Verizon and SBC have started to do.

MCI, which has 41,000 employees, posted $27 billion in revenue and $22 billion in profit in 2003, and its finances were boosted by cancellation of its debt in bankruptcy. MCI now has $5.9 billion in debt and $5.6 billion in cash.

MCI made its name in the mid-1980s competing against AT&T in the consumer long-distance business, but its business today is built around selling phone and Internet service to large corporate clients.

Until last year, the company competed against regional phone companies such as Qwest and Verizon by leasing lines from those companies and reselling local service, but it has backed out of the retail consumer market and its international and long-distance businesses are in decline. Binding itself to a stronger regional telecommunications company with broader offerings would allow the company to survive, company sources said.

Since taking over in November 2002, MCI chief executive Michael D.
Capellas's primary objective has been to clean up the company's accounting problems and then swiftly sell the firm, sources close to the company and on Wall Street said. The company started its most recent discussions with Qwest at the end of last year, said a source close to the companies.

MCI's bonds dropped yesterday.

"The market was disappointed that a sub-investment grade borrower came into the market to make a bid, and that caused [MCI's] bonds to trade down a bit," said John T. Fruit, a debt analyst at U.S. Bancorp Asset Management in Minneapolis.