BT seems to have got away with it, but only just

Comment

Phew! Saved by regulators. It isn't often that Sir Iain Vallance, chairman of British Telecom, has cause to thank the watchdogs that govern his industry but on this occasion he certainly does. Rarely have investors had as close a shave as the huge overvalue BT so very nearly ended up paying for MCI of the US. But for the tardiness of the Federal Communications Commission in the US in approving the deal, the merger would have sailed through months ago on the original inflated terms.

The subsequent damage to BT shareholders, judging by yesterday's new terms, would have been pounds 3bn to pounds 4bn. It seems at least questionable that either Sir Iain or his chief executive Sir Peter Bonfield, could have survived such a costly and embarrassing error of judgement.

As it is, regulators took long enough in approving the deal to allow MCI's problems both in its core long distance business and its assault on local telecoms markets in the US, fully to emerge into public view. How BT and its advisers failed to spot these difficulties at an earlier stage is another question. BT has owned 20 per cent of MCI for some years and is already represented on its board. If anyone had an insider's view of what was going on at MCI, it was BT.

Furthermore, James Dodd, senior telecoms analyst at Dresdner Kleinwort Benson, and others, had spotted and aired in the City the potential for serious difficulties in local telecoms long before BT forced its American partners to put out that infamous profits warning.

Thankfully BT has now managed to renegotiate the terms in a way that allows honour to be satisfied all round. It was touch and go. MCI will almost certainly face a flurry of litigation in the US from angry arbitrageurs and others whose fingers have been badly burnt by the turn of events. Documents filed in connection with the takeover indicated that there was no scope for renegotiating the terms. It could also reasonably be argued that the unexpected events to hit BT since the merger was announced - the windfall profits tax and the removal of tax credits on dividends - went some way to cancelling out the deterioration in MCI's outlook.

In the end, however, a less advantageous deal for MCI was better than no deal at all. Without the prop of the BT takeover, MCI's share price would have headed a lot further south than it already has. The latest terms finally dispense with the pretence that this is a merger of equals. MCI shareholders end up with just 25 per cent of the combined company under the new offer, against more than 34 per cent under the old. The cash element of the bid is enhanced a little, but this does no more than compensate MCI shareholders for the BT final dividend they will now not be getting.

There will be some earnings dilution next year and the remainder of this year, BT says, but thereafter the deal should begin to wash its face. In all then, BT looks to have ended up with if not quite a bargain, certainly a rather better deal than if none of this had ever happened. The bigger question raised by the debacle, however, is whether BT should be buying MCI at all.

I've always largely gone along with BT's case for the MCI takeover but there is no doubt that MCI's difficulties have raised some very pointed questions. Does BT really need to buy another commodity telephony business to further its international ambitions? After a prolonged period of spectacular growth in the US during which MCI provided the main competitive challenge to AT&T, MCI is now finding the going much tougher. Growth rates have slowed and the long distance market in the US has become very much more price competitive.

Moreover, BT already has a highly successful joint venture with MCI in the services it is most interested in developing - one-stop telecommunications for big multinational business. Does it really need to go the whole hog and merge with MCI further to develop this business? Of course it doesn't. BT and MCI come at these markets from really quite different perspectives. BT is the incumbent public telephone company, attempting to defend its market position against bucaneering newcomers. MCI is the very reverse. It is one of the outsiders trying to muscle in, an attacker of markets rather than a defender of them.

Sir Iain Vallance has tried to present this difference of approach and culture as a boon which will be of profound assistance to BT as it mounts its assault on Europe's newly deregulated telecommunications markets. But it could just as easily work the other way round. The two may find themselves incapable of living with each other.

Despite these doubts, this is probably still the right deal for BT to be doing. The case can be argued on a number of fronts but perhaps the most compelling is that size for the sake of it may actually count for something in these fast changing and rapidly globalising markets. What is BT supposed to do? Hand all its surplus capital back to shareholders and then simply settle down to managing the decline of its own domestic business? Few managements worth the name are going to be satisfied with such a dismal task.

Combined, BT and MCI become the third largest telecoms company in the world. Arguably, it will also be the one with the greatest international spread. The upshot is cheaper capital and an ability to take risks and seize market opportunities in a way that neither could realistically do on their own. This has been characterised by some as a thoroughly bad thing. MCI will merely end up using BT's money to advance its own uneconomic push into local US telecoms, many are warning.

But it is not really like that. Of course some of what BT and MCI do together won't work out and there will be losses that on their own neither company would find easy to justify. Some of these more risky propositions will come good, however. On balance, the greater market power that size for its own sake gives will enhance the prospects of both companies. If this were BT buying, say, a US television network, or some such other business which is seen to be converging with telecoms, then there would obviously be room for doubt. But it is not. MCI is in the same business as BT. What's more it is a business where boundaries are fast breaking down.

Not everyone will be convinced by this. BT can still expect quite considerable shareholder opposition when the MCI takeover is put to the vote. Even so, at this juncture it looks as Sir Iain has got away with it after all.