MCI Communications Corp. and International Business Machines Corp. yesterday announced a strategic alliance that promises a major escalation of competition in the telecommunications industry and especially in the long-distance telephone business.
In a complicated transaction, estimated to exceed $1 billion, that surprised the telecommunciations and investment communities, the two companies announced that IBM will initially acquire a 16 percent stake in the Washington-based MCI with an option to buy up to 30 percent of MCI over the next three years.
In return, under an agreement reached in principle, IBM will give MCI the bulk of the assets and operations of Satellite Business Systems. SBS, also based in Washington, is the telecommunications joint venture by IBM and Aetna Life & Casualty that has specialized in long-distance services to businesses.
The alliance gives MCI access to badly needed capital as well as the vast technological and marketing power of IBM, enabling it to be a much more formidable rival to American Telephone & Telegraph Co. in the battle for long-distance customers. But even more significant, said financial analysts and telecommunications executives, the investment in MCI completes IBM's transformation into a telecommunciations company and pits IBM directly against AT&T in almost every segment of the computer and telecommunications market.
"If there ever were any doubts about convergence and confrontation between AT&T and IBM, they should now be resolved" under the MCI deal, said John Bain of Shearson Lehman Brothers. "There is going to be a war . . . and one between two 800-pound gorillas," Bain said.
AT&T, freed by court-ordered divestiture in 1984 from government restraints that barred it from entering the data-processing business, is moving increasingly into that expanding field, not only offering its own family of computers but also forming partnerships with computer makers here and abroad for future products and services.
IBM, meanwhile, has been moving rapidly into the telephone and telecommunications business. Last year, it bought one of the nation's leading telephone equipment manufacturers, Rolm Corp., for $2.5 billion. With the MCI deal, IBM "is planting the flag for a much much bigger stake," said Randall A. Tobias, chairman of AT&T Communications, the company's long-distance arm.
The stock market interpreted the MCI-IBM alliance as good news for both companies. IBM stock rose $1.12 to $122; MCI stock rose $1.50 to $9.50. AT&T's stock, on the other hand, dropped 67 cents to $23.50.
"In terms of the dynamics of competition in the telecommunications industry, it is hard to imagine anything more dramatic could occur," said Philip Verveer, a Washington lawyer specializing in the telecommunications industry. "The industry outlook is completely different than 24 hours ago. It assures that IBM will continue to play in the industry in a major way and suggests that AT&T will have at the least a second reasonably small competitor for the long-distance business," Verveer said.
Under the transaction, MCI Chairman William G. McGowan said he expected that his company's share of the long-distance market -- now estimated to be about 5 percent -- would increase initially by another percentage point with the acquisition of SBS. Over the long run, however, he said he expected the acquisition to enable MCI to grow faster and be a stronger competitor to AT&T.
Last year, MCI's revenue totaled nearly $2 billion, compared with AT&T's total revenue of $33 billion. Almost half of AT&T's operative revenue last year came from sales of telecommunications services, primarily its long distance business.
IBM had $45.9 billion in sales last year and it ranked first among U.S. manufacturers in profits.
SBS's revenue for 1984 was nearly $300 million. However, SBS -- an 11-year-old company that started as an equal partnership by IBM, Aetna and Communications Satellite Corp. (Comsat), has never made a profit. The three companies have poured a total of $1.3 billion into SBS, which was designed to provide sophisticated satellite telecommunication service to large businesses with many offices spread around the country.
The losses ultimately forced Comsat to drop out of the venture last year, with IBM and Aetna dividing up Comsat's shares so that IBM owned 60 percent of SBS and Aetna the remainder.
Under the agreement announced yesterday, IBM will buy out Aetna's share of SBS for an undisclosed price. Then, it will turn over most of SBS' assets and operations to MCI, taking over $400 million in SBS debt.
In exchange for the SBS assets, MCI will issue IBM 45 million shares of newly issued stock -- giving IBM an immediate 16 percent stake in MCI, making it MCI's largest stockholder.
The price of the stock transaction will be based on MCI's stock price the day the deal is closed -- a day that is expected to be at least three to four months off because the agreement requires the approval of the Federal Communications Commission and the Justice Department. However, based on yesterday's closing stock price, the stock offering would be worth $427.5 million.
Additionally, MCI has agreed to give IBM rights to purchase an additonal 7 million shares of MCI stock at $15 a share, worth another $105 million. IBM has agreed to hold its shares for a minimum of three years.
During that time, IBM has also agreed to invest another $400 million in MCI securities. However, under the agreement, IBM will not increase its total interest in MCI common stock beyond 30 percent without MCI's approval. MCI and IBM said they had not decided whether IBM representatives would have a seat on MCI's board.
Antitrust experts yesterday said they doubted that the Justice Department's antitrust division would try to block the agreement -- AT&T's huge presence in the telecommunications market makes that unlikely, they said.
McGowan said he initiated talks that led to the agreement about two months ago, after concluding that there would soon be major consolidations in the long-distance business. Over the past few months, many of AT&T's small rivals have been calling for special government breaks to help them compete against MCI. Without these advantages, many have said they may be forced to go out of business.
IBM's vice chairman Paul J. Rizzo said IBM was willing to talk because it had concluded that it would have to continue to pour in a substantial amount of money in SBS over the next three years to make it profitable. "We would prefer to put that extra investment into MCI rather than SBS," Rizzo told a press conference.
Yet, he added, "we have not agreed to be the deep pockets of MCI Corp. Unless the economics of this industry end up making sense, further investment will be very difficult to attract IBM or any other company."
Rizzo said he anticipated that IBM, with MCI and Rolm, can be expected to bid to supply large complete telecommunications networks, particularly for the government.
However, he added, "I find it difficult to believe that by this move we are going to go the the heart of AT&T business, which is orders of magnitude greater" that MCI, he said.
Despite the continued string of losses at SBS, McGowan said he was confident he could turn the company around within a year, chiefly because MCI will be receiving the company totally free of its $400 million debt.
McGowan said he planned to keep most of the SBS employes.