For now, the fight is between WorldCom, whose shares have done fabulously well but have more ups and downs than an elevator with hiccups, and GTE, which is offering cash on the barrelhead. Moolah, long green, the stuff you actually take to the bank. (There’s a third offer on the table, from British Telecom, that’s about 80 percent stock. But unless BT ups the ante sharply, it’s history as an acquirer of MCI.) This whole mess could get messier if AT&T or one of the five Baby Bells or another foreign telecom giant comes out to play. Could easily happen–especially if AT&T’s rumored new chief executive, Hughes Electronics’ Michael Armstrong, gets the job and wants to prove AT&T is still active (box).
But instead of getting into the $41.50-versus-$40 new math, let’s focus on some boring old math. To wit: if a capital-intensive business like a phone company is gonna borrow more money than many countries do, it’s a good idea to make sure it will still be able to pay its bills and reinvest in its business and keep faith with shareholders who depend on getting cash dividends. It looks to me like GTE would be hard pressed to do all this while borrowing $29 billion to buy MCI. GTE, as you would expect, disagrees.
In case you’re trying to understand what $29 billion of cash means, think of it as 116 billion 25-cent pay-phone calls–more than 400 calls for each man, woman and child in the United States. If President Clinton continued his average of raising $270,000 per White House coffee, it would take him almost 300 years if he did one a day. GTE wants to pile this $29 billion of borrowed money atop its existing $17 billion of debt and MCI’s existing $5 billion. GTE, the nation’s biggest non-Bell local phone company, says if the deal goes through as planned, the new company would start life owing $54 billion.
GTE and its supporters on Wall Street say this is no problem, because GTE and MCI are solidly profitable and can handle the debt. ““We’re comfortable with this,’’ GTE chairman Charles Lee said in an interview. But with all due respect to Lee, who’s done a fine job trying to adapt GTE to today’s madly changing telecom environment, the prospect of all this debt piled on this company makes me twitch. Let me show you why. What matters in the real world isn’t the profits you show or your operating income, numbers that GTE proudly brandishes. What matters is a number that no one is talking about: how much you have left after you pay your bills, reinvest in the business and pay dividends to your shareholders. That’s what financial analysts call ““free cash flow.’’ It’s your margin for error.
Look at GTE’s free cash flow. There isn’t any. The company’s operations produced $5.9 billion of cash last year. But it shelled out $4.1 billion for capital expenditures and $1.8 billion for dividends. Free cash flow: zippo. GTE insists it won’t cut the dividend, which, at $1.88 a share, was a fat 4.1 percent of GTE’s closing stock price on Friday. As an old-line phone company, GTE has lots of so-called ““widow and orphan’’ investors who depend on dividend income. Who wants to trash widows and orphans?
If you do the math on MCI, you discover that it has no free cash flow, either. Combine these companies, add $29 billion of debt, which will require more than $2 billion of annual interest payments, and what have you got? A big mess. It’s hard to see how the company could pay the interest, plow the necessary money into new facilities, withstand the price war that GTE acknowledges is coming in both long-distance and local service and pay its dividend. Something would have to go.
Mike Kelly, GTE’s chief financial officer, concedes that I’m right about the lack of free cash flow. But, he says, the free cash deficit, once quite large, is now almost gone. (It was about $14 million last year, but it disappears in our rounding.) Even though the first half of 1997 also had negative free cash, he says, the tide is turning, and the company expects to show $500 million of free cash this year and much more in the future. Kelly says that MCI, which raised its spending sharply the past few years, will cut it back or hold it steady, and will soon turn strongly positive, too. Combine that with all sorts of extra business and higher profits that GTE claims it will get from combining with MCI–to which I say, ““good luck’’–and things will work out fine.
Please don’t think this means that I’m a WorldCom partisan. WorldCom is a fascinating, fun company–but it’s so busy absorbing all the things it bought that you can’t tell what’s going on.
The clear winners here are MCI shareholders and, to an extent, British Telecom. Having bungled the MCI acquisition, BT, by virtue of its 20 percent stake in the company, has a major say in who ends up owning it. And will probably end up extracting some sort of deal from the winner. Talk about luck. As one dealster who claimed to be citing an old Chinese proverb put it, even a blind cat can sometimes find a dead mouse.
COMPANY, CEO TOTAL BID WorldCom, $30 billion at $41.50 Bernard Ebbers per share in stock GTE, $29 billion at $40 Charles Lee per share in cash BT, $20 billion at $35.30 Sir Iain Vallance per share in cash/stock
