Bumblin' and Fumblin' With Qwest

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David Sims
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Bumblin' and Fumblin' With Qwest

Floyd Norris of the New York Times offers his take on why, even at the lower price, Verizon is still the better option for MCI than Qwest, which is punching far above its weight class:

MAJOR institutional investors are up in arms over the way MCI has conducted itself in finding a buyer. Its board so far has backed the lower bid from the company that can best afford it, Verizon, rather than the higher bid from Qwest, a company that is, to put it gently, financially challenged.

"The question is not whether Verizon is a larger, more financially sound company that possesses assets, such as wireless, that Qwest lacks," Bill Miller, the chief investment officer at Legg Mason, wrote in an angry letter to MCI. "It is and it does. The question is which transaction creates the most value for MCI owners."

To Mr. Miller, who owns substantial stakes in both MCI and Qwest, the answer is clear. But perhaps it is not quite as obvious as the numbers would seem to suggest.

The reason is that both the Verizon and Qwest offers include common stock. And there are historical reasons to question whether Qwest shares will prosper.

Such a takeover would be unusual in a couple of ways. First, Qwest trades for less than $4 a share, far below the ordinary price for an acquirer. Second, its total stock market capitalization, around $7 billion, is less than the $8.9 billion in stock and cash it is offering for MCI.

I asked Rene M. Stulz, an Ohio State professor who has done extensive work on mergers, to check how deals with that combination have done in the past. He and his colleague, Sara B. Moeller of Southern Methodist University, found 49 such deals from 1980-2002. On average, over the next 400 trading days, about 19 months, acquirers underperformed the market as a whole by a stunning 56 percent. "Acquirers have poor returns after the acquisition," he said, "but the ones like Qwest appear to perform twice as poorly as the average acquirer."

Why should that be? First, no respectable company wants a share price under $5, and those that have one usually have suffered problems and are hesitant to get the price up with a reverse split, since values often fall after such a split.

If such a company instead seeks to buy a larger company when its own share price is in the dumps, that may be a sign of desperation. Ms. Moeller reports that companies that try such takeovers but fail to complete them do a little worse than those that do complete them.

It is not hard to understand why Qwest, the result of one of the worst mergers of recent years, would feel a need to roll the dice. Nor is it hard to understand why MCI's board would be a little gun-shy about merging with a company with a history of phony accounting, even if it does have a new management. This board presided over WorldCom's bankruptcy, after which it was renamed MCI. Old WorldCom shareholders got nothing.

That Qwest can borrow cash to partly finance this transaction is a testament to just how easy credit is now. But the fact a highly leveraged company can borrow more does not prove it is a good idea to do so.

Many MCI holders will take the cash and run, and could not care less what happens thereafter. Some even prefer Qwest because it is easier to hedge the value of a stock that does not pay a dividend - like Qwest - than one that pays a good one, like Verizon.

That is not a long-term view, and MCI's board could set it aside. But it is offensive for Verizon to pay one shareholder more than others, as it now wants to do. And there are limits to the quality premium Verizon deserves. Leon Cooperman, whose hedge fund has a large MCI position, says it might be reasonable to prefer Verizon if the figures were close - "a few percent discount at most."

MCI as a company, and its employees, would probably do better with Verizon. But Verizon may have to be nicer to MCI shareholders for that to happen.


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