Pressure on BT to call off MCI deal

British Telecom's $20bn (pounds 12bn) merger with MCI appeared to be on shakier ground last night after the US company said it had no intention of renegotiating the terms of the deal following its shock profits warning late last week.

A spokesman for the company, America's second largest long-distance operator, said: "We believe the terms of the merger will remain in place and we expect the merger to move forward as planned."

Stock market speculators, otherwise known as arbitrageurs, stand to lose huge sums of money - perhaps as much as pounds 1bn - if the merger terms are altered substantially or if the deal is called off altogether.

Despite MCI's insistence that the merger will go ahead as announced, a number of BT's largest institutional shareholders have warned that it now has no option but to renegotiate the terms after MCI warned it could lose $800m this year on its move into the local US telephone market and as much as $1bn next year.

BT may need to reduce the offer price by as much as $2bn to compensate. But some analysts are arguing the price should be reduced even further or BT should pull out altogether and pay the $150m penalty fee it would incur.

The shock profits warning and the apparent stand-off between the two companies is likely to mean fireworks when shareholders gather for BT's annual meeting in Edinburgh tomorrow. What had been billed as a routine, boring agm has suddenly escalated in importance as the BT board frantically prepares to placate angry shareholders.

Investors will demand to know why the profits warning came so late and so unexpectedly and how BT proposes to modify the terms of the deal.

MCI's two most senior executives - chief executive Bert Roberts and chief operating officer Gerald Taylor - will be at the agm in their capacity as non-executive directors of BT and are likely to face heavy flak from angry shareholders who voted the deal through overwhelmingly three months ago.

The merger agreement gives both sides the right to renegotiate the terms should there be a material change in the circumstances of either company. BT's institutional shareholders argue that a profits warning which in effect robs the merged company of any earnings growth for two to three years should trigger a renegotiation.

However, MCI shareholders, including a number of "arbs", are likely to argue that the increased pension liabilities BT faces following the abolition of dividend tax credits also amount to a material change. BT estimates that the changes, announced in the Budget, will reduce pre- tax profits by pounds 150m-pounds 200m a year.

The arbs are in a heavily exposed position because of the way they have sought to exploit the gap between the price of MCI shares and the terms on offer from BT.

BT is paying 5.4 BT shares and $6 in cash for every MCI share which, before the profits warning, produced a spread of up to 10 per cent between MCI's offer price and its market price.

The arbs have in effect been buying into BT cheaply by acquiring MCI shares and going short on BT - offering to sell shares they do not own in the expectation of being able to cover their positions when the deal goes through.

One BT insider said that it had been inundated with frantic calls from arbs last Thursday evening when the profit warning emerged. "We took scores of calls from arbs saying they would be driven into bankruptcy. One of them was almost in tears. He wanted me to tell him he was just having a bad dream."

BT's finance director, Robert Brace, will fly out to the US after the agm, heading up a team that will assess the MCI profit warning and its plans for entering the US domestic market and report back on whether the merger terms need amending.

BT described reports that it would demand the resignations of two senior MCI executives as "speculation". MCI also played down suggestions that the two - finance director Doug Maine, who is due to become finance director of the merged group, Concert, and Tim Price, head of its US telephone business - would be forced out. "MCI has a very strong management team," said the spokesman.

BT shares closed 16p higher last night at 456.5p having fallen by 8 per cent last Friday in the wake of the profits warning, while MCI shares were $2.25 firmer at $37.25.

Comment, page 19