Telecom M&A Activity Likely To Increase
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Next year should be much busier for mergers and acquisitions in the telecommunications sector. Of course, the sector is rebounding, the cost of capital is still relatively low, and the weak dollar is attracting the eye of overseas investors.
As important, the regulatory climate in Washington is far more conducive to M&A activity in 2005 than in 2004. Two events this week illustrate why.
Sprint and Nextel are negotiating a possible merger. Speculation has mounted for much of the past year that one or both of these companies would be involved in a major merger. But the final details of a deal needed to wait until after the presidential election to estimate rationally the cost of a merger.
With President Bush’s victory, mergers between large corporations are likely to be approved more quickly and with fewer conditions than had Senator Kerry been elected. And with no elections in 2005, politicians for the next 12 months are less likely to tut-tut – or to be embarrassed by – the mergers of large corporations. That’s why, barely six weeks after the election, the Sprint and Nextel merger talks are public.
Merger and acquisition activity will focus on the telecommunications sector because of substantial changes in the regulation of the industry. On Thursday, the Federal Communications Commission will adopt new regulations for the leasing of telecommunications networks that will be far more favorable to incumbent telephone companies than the types of rules that have prevailed for more than eight years.
The Clinton Administration, despite protests of neutrality, actively supported the competitive local exchange carriers such as AT&T and Level 3,against incumbent telephone companies, such as Verizon and SBC. During its first three and a half years, the Bush administration maintained neutrality between the warring factions in the industry.
No longer. As of this past summer, the Bush administration and the FCC are squarely on the side of the incumbent telephone companies. The new FCC rules will reduce the opportunities and raise the costs of being a wireline telecommunications competitor.
No one should have illusions that the FCC, having consistently lost in court for many years on the same section of law, has suddenly divined new legal insights. But the competitive telecommunications industry probably lacks the fortitude and financial wherewithal necessary to prepare a compelling legal case to defeat the FCC.
Over the past several years, the repeated court defeats for the FCC and resulting uncertainty about the most fundamental issues of federal telecommunications regulation have crippled incentives to invest in the telecommunications industry. This week’s rules will not bring the promised increase in industry investment in plant and equipment. Repeatedly burned by mercurial and legally unsustainable FCC decisions, investors will reasonably doubt whether the most recent rules will long survive.
But the new FCC rules may alter investor views of the corporate structure of companies. In a break with past regulations, smallness in a telecommunications firm is no longer favored by federal regulators today, nor likely will be for many years to come.
The new FCC rules will likely reduce the number of viable wireline competitors in a local market from dozens to less than a handful. One firm owning a combined telecommunications network covering much of a region will have a greater success under the new rules than a patchwork quilt of separate telecommunications networks owned by two dozen different companies. The remaining competitors, many of which are in or near bankruptcy, have little choice but to consolidate.
It is not obvious that the surviving competitive wireline carriers will each have a national footprint. In the years before telecommunications competition was federally mandated by the Telecommunications Act of 1996, two of the most successful competitive companies – MFS and Teleport – started as small regional firms.
It is also not obvious that the surviving competitive telecommunications companies will resemble traditional telephone companies. Increasingly, wireless firms such as Nextel and internet-based firms such as Vonage compete for the same customers with traditional telephone companies. This wider competition bodes well for the antitrust review of potentially merging large telecommunications firms such as Sprint and Nextel.
Next year should bring substantial consolidation among the large number of both publicly traded and privately held competitive wireline carriers. It is none too soon.
A former FCC commissioner, Mr. Furchtgott-Roth is president of Furchtgott-Roth Economic Enterprises. He can be reached by e-mail at hfr@furchtgott-roth.com.