MCI TAKEOVER BATTLE

MAYANK JOSHIPURA

The motivation of MCI shareholders,

the MCI board, Verizon & Qwest
MCI
AT&T-SBC deal set the stage for Verizon
offer for MCI
MCI emerge from Bankruptcy with $5.5
bn of cash and $6bn of debt compared
to $30 bn in 2001
Good business in enterprise services
with strong long distance presence
Greenhill was an advisor to MCI board

 Verizon
Little uncertainty about the deal due to size and
strength of Verizon
Debt of $39bn but market cap of $100 bn
Verizon-MCI could well be counterweight to SBCAT&T. Bear Stearns was the advisor
Verizon was significantly less leveraged compared to
quest both on market and book value based D/E or
D/V ratio (with or without adjusted for cash)
Larger asset base and low financial leverage can
provide attractive fund raising opportunity and
therefore low uncertainty on completion of deal

 Qwest
Much smaller than Verizon. Acquired US West in 2000
and touched market cap of $68 bn year 2000
Now only $7bn in market cap and its offer for MCI is
more than its market cap
$17bn in debt and $1.7bn in cash
Difficult to raise funds for the deal and greater
uncertainty
However, MCI shareholders can own more than half of
combined entity compared to only small portion if
acquired by Verizon
So if MCI is currently undervalued Qwest offers much
more upside to MCI shareholders

Fiduciary Duties
If firm is not for sale board can turn
down offer higher than its market value
if feels that remaining independent is in
the interest of firm
If for sale then it has to go with higher
of the cash offer if its a cash deal
In case of cash + stock swap or stock
swap deal board has discretion in terms
of favoring one offer over the other.

 Shareholders horizon
If shareholders are interested in owning stake
in acquirer after the deal for long time should
board consider fundamental value of
acquirer?
Can management of target play trick by
rejecting genuine offers on the ground of
fundamental value?
In 1998, BT and GTE made offers for MCI,
WorldCom offered more in terms of stock
price prevailing then.

Stock market driven

acquisitions
Acquirers may use overvalued equity as Cheap currency
AOL-Time Warner is a classic example
Acquisitions made by WorldCom and Qwest in 2000 are
classic example in the case/industry
Letter from Verizon CEO to board of MCI highlights
Qwest promised shareholders of US West with increase in
revenue by $12 billion ($4.1bn incremental EBITDA!) and
operating cost savings of $4.4 bn and reduced capex by $2.2 bn
cumulatively within five years
Result? Actually revenue and EBITDA went down! Everyoneemployees, customers, suppliers suffered! Qwest stock price
came down from $50 to low single digit.
False promises at the time of WorldCom-MCI deal led WC to
accounting fraud. (Exhibit 10)

Valuing the two offers:$7.6 bn vs.

$8.4bn
Use of collars (Exhibit 7)
Verizon offers $8.75 in cash and at least $14.75 in
stock.
i.e. if Verizon if trading at $30 then the exchange
ratio is $14.75/30 but if it trades at $14.75 its 1:1.
In no circumstances Verizon offers ER of 0.4062,
which means if stock crosses $36.31 MCI
shareholder will have more upside from this call
option
Can be interpreted as $23.5 + 0.4062 call options

Qwest offer
$10.5 cash + $15.5 in stock
However it provides $15.5 only if stock price remains
within $3.74 to $4.57. i.e if Qwest is trading at $4
then MCI shareholders get 15.5/4 shares of Qwest
Under no circumstance MCI shareholders get fewer
than 3.392 shares of Qwest which means 3.392 call
options at $4.57.
But, under no circumstances Qwest shareholders get
more than 4.1444 shares of Qwest. Which means if
price falls below $15.5/4.1444 MCI shareholders may
not get $15.5. Similar to short position in put where
fall in stock price leads to unlimited loss.

Valuation
MCI shares (000)= Exhibit
5

326,431

Rf = ln (1 + Rate in table A)

3.35%
Verizon

Qwest

Cash component-Exhibit 7

$8.75

$10.5

Stock component-Exhibit 7

$14.75

$15.5

Current Exchange RatioExhibit 7

0.4231

4.0897

Min exchange ratio-Exhibit 7

0.4062

3.392

Max exchange ratio-Exhibit 7

None

4.1444

Volatility-Implied from page 5

19%

45%

Price-page 5

$34.86

$3.79

Time to completion-page 5

Div yield = ln (1 + yield on

page 5)

4.32%

0%

Valuation cont.
Verizo
n

Qwest

Bond

Calls@36.31 Bond
2

Puts@3.74 Calls@4.
0
57

Quantity

23.5

0.406

26

-4.144

3.392

Rf

3.35%

3.35%

3.35
%

3.35%

3.35%

Div yield
T

4.32%
1

Vol

19%

45%

45%

S0

34.86

3.79

3.79

X (S0/ER)

36.31

3.74

4.57

d1

-0.17

0.33

-0.12

d2

-0.36

-0.12

-0.57

BS Price per option

1.82

0.58

0.46

Connected PV

23.46

24.31

Merger Arbitrage & Price

pressure
Merger arbitrage in cash deal is simple- buy target stock at

discount to cash offer price from the market and simply wait
for deal to conclude
In stock swap deal buy target shares and short acquirers
share based on ER
In a collar deal arbitrageur must use either options or
dynamic delta hedge. With each MCI share bought one has
to short 0.18 Verizon or 3.08 Qwest shares depending on
probability assigned by him.
This leads to huge price pressure on Qwest shares and
therefore decline in price. Below a particular price there is
no portion to MCI shareholders cash equivalent of stock
component and that should be kept into consideration
MCI has many hedge fund investors as it has just emerged
from bankruptcy

What happened?
March 29- Verizon increased bid to $23.50, MCI board
accepted and signed amended MA
March 31- Qwest increased cash component to $13.1 and
total bid to $27.5
April 5-MCI board stayed with Verizon and rejected Qwest bid
April 9- Verizon agreed to buy 43.4 mn MCI shares from
Carlos Helu at $25.72
April 21- Qwest revised bid with cash component of $16 and
total bid $30
April 23- MCI board accepts it
May 2- Verizon revised bid to $26 and MCI signs AMA. Qwest
exits the race
Jan 6, 2006- Verizon completes acquisition of MCI