Mother and Child Reunion: Will the AT&T/SBC Merger Build or Destroy Value?Published: March 30, 2005 in Knowledge@Wharton
Wharton professor Gerald Faulhaber, who was the chief economist at the Federal Communications Commission from 2000 to 2001, has his doubts. "I think this deal has a great potential to destroy value," he says. "What is SBC going to bring to the table? At $16 billion, there's a lot of downside to this merger."
While it is too early to predict whether SBC will be able to create a company that in Whitacre's words will "renew America's leadership in communications technology," the questions that need to be addressed are clear, say Wharton professors. Will SBC get regulatory approval for the merger? Will SBC be able to keep AT&T's corporate customers, a crucial factor in SBC's desire for the merger? What will SBC do with the AT&T brand? Will consumers suffer? And is SBC willing to forge ahead with new technologies such as voice over Internet Protocol (VoIP)? How will SBC compete with cable firms such as Comcast, other regional Bell operating companies like Verizon, and upstarts such as Vonage?
It may be take a year or more for answers to those questions to emerge. SBC expects the AT&T deal to close in the first half of 2006 after the U.S. Justice Department, the Federal Communications Commission, state public utility commissions and foreign authorities give their approvals. Consulting firm Gartner, however, says "the deal has at least a 70% chance of approval, though the June 2006 target date is optimistic." Kevin Werbach, a Wharton professor of legal studies, says a lot could happen between now and then. "That's a long time," says Werbach. "This process could mean a 12- to 24-month period of stasis."
In the meantime, on February 1 SBC outlined its plan to meet its cost-cutting targets. In a presentation given to Wall Street analysts after the merger was announced, SBC executives outlined plans to cut 13,000 jobs, or 12% of their combined 163,000 work force. Many of those cuts are likely to occur through attrition. The annual savings are seen at $200 million to $600 million by the second half of 2006, reaching $2.4 billion to $2.9 billion by 2009, according to the companies' executives. SBC says that just collapsing redundant sales, network and customer care costs in the two companies' enterprise businesses would save $1.5 billion a year.
Faulhaber admits that SBC is known to be tough on costs, but the merger's long-term success doesn't necessarily depend on the company being lean and mean. The bulked-up SBC will have to find a way to grow. For 2004, SBC sales were up 0.7% to $40.8 billion. AT&T's sales declined 11.6% to $30.5 billion in 2004. Traditional telecommunication players like SBC are losing customers to cable firms as consumers move to VoIP and wireless companies. "This will be the year of VoIP implementation," says Faulhaber. "Half of the U.S. will soon have broadband, and voice is the killer app."
In Search of Corporate Customers
Despite his concerns about the merger, Faulhaber admits that SBC does acquire AT&T's extensive list of corporate customers. "AT&T has an enormous presence in the corporate world," he says. "None of the regional Bells have that traction." Werbach says AT&T also gives SBC a national infrastructure to acquire corporate customers and build its revenue base. AT&T's network crisscrosses the entire country while SBC's has gaps in territories dominated by other regional operators such as Verizon, BellSouth and Qwest Communications.
In addition, SBC acquires AT&T's long distance customer base, which could be used to market other services. To be sure, long distance is a dying business, but AT&T still is a major player despite its recent focus on corporate customers.
Another key -- yet underappreciated -- asset in the deal is AT&T CEO David Dorman. Werbach notes that Dorman, who will become SBC's president after the deal is closed, is likely to be the heir apparent to Whitacre. Dorman was chief executive of PointCast, a dot-com era firm that pushed content to the desktop, and is a veteran of Sprint and Pacific Bell, which was acquired by SBC. "Dorman is willing to shake things up and try new technologies," says Werbach. "He's a bit of a revolutionary."
Other key executives include AT&T's widely respected chief technology officer, Hossein Eslambolchi.
Brand New Questions
Perhaps the most unquantifiable asset in the merger is the AT&T brand. By adopting the AT&T moniker, SBC could craft an identity as a national player. SBC, however, has been silent on how it intends to use the brand.
Marketing professor David Reibstein says SBC will have to decide whether it wants to keep the AT&T brand, adopt it over SBC's, try multiple brands or create a new identity altogether. "What is the AT&T brand really worth? That's the big question," he says. Reibstein explains that AT&T's brand value is murky right now. On the positive side, it is a well-known brand that has global recognition. The negatives, however, are clear. AT&T has been in decline for years with its most recent retreat coming in July 2004. AT&T said at that time that it would stop promoting consumer local and long distance services to focus on corporate customers. Simultaneously, AT&T declared it would focus on its own VoIP service, which it dubs CallVantage.
Reibstein believes SBC might opt to create a new name. This strategy worked well for Accenture, which dropped its Andersen Consulting moniker before parent Arthur Andersen went out of business following the Enron scandal. Bell Atlantic completed acquisitions of Nynex and GTE in 1997 and 2000, respectively, and became Verizon. "Sometimes it's easier to create a new name and change your positioning than to keep the old name," says Reibstein, adding that SBC could "keep both brands, and it could work out."
While Werbach notes AT&T has some attractive assets, others fear that the company also has problems that could undermine the merger's synergies. The biggest challenge is that most of AT&T's businesses -- with the exception of its corporate network services -- are struggling, according to Faulhaber. If that is true, it suggests that SBC may have overpaid for AT&T. "AT&T has a strong brand, but it does come with baggage," he says. "Its business is dying."
Wharton professors note that it is also unclear how much AT&T's business will continue to erode as SBC waits for regulatory approval. During the next year, AT&T's long-distance business could continue to deteriorate and corporate customers could look to rivals such as MCI and Sprint because of concerns about the SBC deal. Meanwhile, a delay in approval from regulators is not out of the question. Although approval of the deal is likely, the merger "is no slam dunk," says Faulhaber. The merger will likely be viewed as though Ma Bell is being put back together. It's possible that SBC and Verizon will eventually operate a duopoly.
The consensus view is that regulatory approval for SBC's acquisition of AT&T could be delayed. "We think that the deal will involve a rather lengthy approval process on a rapidly declining asset, with some divestiture requirements," says Merrill Lynch analyst James Moynihan in a research note.
Regarding the antitrust factor, two areas deserve close observation. One is long distance services, which both AT&T and SBC offer. Consumers could see prices rise as the industry goes through a consolidation after the merger. Moynihan, however, says the merger's effect on consumer long distance rates is "a moot point." The reason, he argues, is that SBC was likely to take AT&T's market share anyway.
Faulhaber points out that a thornier issue for regulators will be SBC's plans for VoIP. AT&T, which offers the CallVantage VoIP service, may face pressure to shut it down after the acquisition, because it competes directly with SBC's offerings. Regulators should be concerned that SBC might squash CallVantage in order to eliminate a future rival. "Do we really want to shut that off?" asks Faulhaber.
Werbach explains that VoIP on its own may not stop the merger. "VoIP is so tiny now, it won't be a regulatory hurdle," says Werbach. He does worry, though, that SBC's purchase of AT&T could give it and Verizon free reign over regulatory matters in Washington D.C. AT&T was one of the few companies that could oppose Verizon and SBC in Washington. In Werbach's view, the only competition the regional Bell operating companies may now face is from the cable firms.
Although the future regulatory landscape is hardly a reason to kill a deal, analysts believe SBC's purchase of AT&T will mean significant changes in the industry. "The regulatory environment has really boiled down to a showdown between AT&T vs. SBC and Verizon," says Bank of America analyst David Barden. "AT&T by and large lost this battle but fought hard. At the conclusion of the SBC/AT&T merger, these two forces will act in concert, on many issues."
Assuming SBC gets approval from all the regulatory agencies, the next challenge will be keeping AT&T's corporate account managers happy. Faulhaber says the SBC and AT&T cultures could clash and spark an exodus of corporate account managers. Faulhaber likens the risks to what might happen at IBM if its account representatives left the company's services division en masse. "What happens to the national account managers is key. AT&T has people who are seasoned, and customers look to them," he says. "These employees are at the core of AT&T's success. If you don't have them, what will happen? This is a trust business."
Given the risks, SBC's best bet may be to leverage back-office and shared services such as human resources, and otherwise leave AT&T untouched. "The big question is whether SBC will leverage AT&T," he says. "The best thing may be to just leave AT&T alone, but that's not the sign of a good merger."
Whether SBC's acquisition of AT&T works out remains to be seen, but the merger announcement has already accelerated consolidation in the telecommunications industry. Days after the SBC/AT&T deal was announced, the Wall Street Journal reported that MCI was in talks to be acquired by Qwest Communications, a regional telecommunications company. Verizon was also reportedly in the mix and may bid. "The starting gun for another round of consolidation has gone off, and MCI and Sprint may be looking for dance partners," says Werbach.
Faulhaber agrees, but warns that not all acquisition targets are created equal. Neither MCI nor Sprint can match AT&T in the corporate market, and both have flagging long distance businesses. He favors Verizon's recent strategy, which has focused on growing its business organically through efforts such as delivering fiber optic lines directly to homes. And even if all the regional telecom players consolidate, they still have to keep customers from ditching their phone lines. Sprint has refashioned itself primarily as a wireless carrier by consolidating its Sprint PCS unit and buying Nextel.
Werbach says wireless is clearly the future, and SBC could have boxed itself into a corner with its purchase of AT&T. The reason: SBC owns wireless carrier Cingular as a joint venture with BellSouth. To jumpstart growth, SBC would ideally gain total control of Cingular. But now that SBC has acquired AT&T, consolidating Cingular by buying BellSouth is highly unlikely because regulators would shoot the deal down over competition concerns. Nevertheless, SBC will have to address the question of Cingular's ownership sooner or later. "That ownership structure will have to be resolved," says Werbach.