U.S. Preparing to Block WorldCom-Sprint Deal

The government is preparing to block WorldCom's (WCOM Quote) $115 billion acquisition of Sprint (FON Quote) on grounds that the deal would weaken competition in the long-distance phone market.

Following weeks of talks aimed at reaching a compromise, Justice Department officials have now shifted their efforts toward building evidence to support an antitrust case, two people with knowledge of the situation say. Antitrust chief Joel Klein may act on the staff recommendation and sue as early as next week, according to these sources, who both asked to remain anonymous.

While the possibility remains that the parties can hammer out some last-second compromise, observers say the matter appears likely headed to court, where WorldCom and Sprint would probably call off the deal rather than fight a lengthy legal battle. The defeat of the merger would represent a major setback for both companies, particularly for WorldCom, which prizes Sprint partly for its share of the lucrative U.S. wireless market. Shares of the companies were narrowly mixed in midafternoon trading Tuesday.

Justice Department officials and WorldCom and Sprint representatives said only that negotiations are ongoing.

Competitive Worries

The central issue for Justice officials is that the merger would consolidate more than 75% of the long-distance market in the hands of AT&T (T Quote) and the Sprint-WorldCom combination. In such a concentrated market, federal regulators see little competitive pressure to keep quality up and consumer prices down.

Justice has a "very good structural case," says Charles Biggio, an antitrust attorney with Akin Gump Strauss Hauer & Feld in New York.

"I don't think the government is looking to fix this deal," says analyst Scott Cleland of Legg Mason Precursor Group, a Washington-based research firm that does no investment banking. "I think their opposition runs deeper."

A Bridge Too Far?

Industry observers have wondered if the Sprint/WorldCom deal ran the risk of taking the telecom industry's consolidation trend too far, a question echoed by Biggio, a former Justice Department official who isn't involved in the case.

Joel Klein "got a particularly bitter taste in his mouth having to approve all these conglomerate mergers between the Baby Bells," Biggio says. "I think Joel felt a little powerless on the other ones, and here's one where he may be saying, 'I'm not going to be the person that sort of exercises prosecutorial discretion and lets the merger happen.' "

WorldCom and Sprint are unlikely to succeed in persuading regulators that the Baby Bells' entry into long distance will immediately create a competitor to the likes of AT&T and the combined Sprint-WorldCom, says Biggio.

A lesser obstacle to the merger is control of the Internet. WorldCom chief Bernie Ebbers has said his prized UUNet division wouldn't be a bargaining chip, but Sprint officials have indicated their Internet backbone assets could be divested. Observers say the Internet problem can be fixed, but that long-distance consolidation presents a nearly unsolvable dilemma.

Dark Clouds

Cleland, who says he believes the merger is unlikely to be completed, also notes that Sprint CEO William Esrey expressed doubt to shareholders last week that Justice would clear the deal.

"That was a huge change in tone," says Cleland. "It was all sunshine and rainbows before that. No one on the company side ever indicated that the deal wouldn't get done."

Cleland also says AT&T's botched attempt to jack up basic calling-plan prices two weeks ago probably showed federal regulators that competition is lacking.

A Different Perspective

Not everyone is so eager to declare the deal dead.

"There have been some political pressures placed on the regulators, and they don't want to be seen as a rubber stamp," says telecommunications analyst Brian Adamik of Yankee Group, which consults to all the major telecommunications companies. Adamik remains optimistic that the merger will clear antitrust scrutiny.

"We always believed that when the dust settled we'd have five to seven major companies," says Adamik. "If Justice blocks this merger, it may help establish those parameters."

But Cleland, who notes the continued optimism in the investment banking community, thinks it's back to the drawing board for Sprint and WorldCom.

"The handwriting is on the wall and Esrey wrote it," says Cleland. "And I don't think the financial analysts are seeing it."