Merger review - BT and Infonet

Lu Shang 4/28/2007

Introduction

A merger refers to the absorption of one firm by another. The acquiring firm retains its name and its identity, and it acquires all of the assets and liabilities of the acquired firm. After a merger, the acquired firm ceases to exist as a separate business entity. In resent years, more and more merger and acquisition happened for those big companies as a result of intense competition in the business world. To maintain the competitive position in their respective areas, merger and acquisition become suitable strategic alternative, which would bring synergy to both companies. Revenue enhancement, cost reduction, lower taxes, and lower cost of capital can be the basic categories of possible sources of synergy.

BT announced in 8 of November, it has signed a definitive agreement to acquired Infonet with $965 million in cash (£520 million). Infonet, a leading provider of global communications services, has a net cash balance of $390 million and that the aggregate worth of the deal was $575 million (£310million). The deal is subject to Infonet shareholder approval and regulatory clearances and is expected to complete in the first half of 2005.

Therefore, Will this newly merged global communications company succeeds? Is there any maintain risk for this combination? Is it worth for BT to acquired Infonet with that amount of money or is it bringing lots benefits to both of the companies? The following content will discuss this in different aspects.

Skepticism about the Deal

First of all, neither of the companies has been successful at increasing their top line revenues. For BT, this acquisition happened just 3 years after took a massive hit from its loss-making joint venture with US group AT&T. The write-down of that joint venture, Concert, cost BT $1.8 billion. In addition, under the agreement, stockholders of Infonet will receive $2.06 in cash for each share of common stock. Therefore it is a real challenge, if BT can manage the integration of these operations well, then it will be a milestone in its transformation into a leading global provider of IT and networking services. Otherwise, the debts will increase, and BT may not afford for any investment or project, the acquisition can be fault.

Infonet also had bad experiences on its parents and got amount of debts need to be paid. Therefore, many people had the different view about this acquisition.

Some industry analysis said that, “For a start, the merger means less choice for users,” said Camille Mendler, an analyst at the London office of The Yankee Group. “For another, BT has been gaining good momentum and an acquisition could slow down the operator. BT has not been good at integrating its acquisitions.”

“Like Verwaayen, Julian Hewitt, chief analyst with Ovum, views the acquisition as a positive move for BT. BT's Global Services ...

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Infonet also had bad experiences on its parents and got amount of debts need to be paid. Therefore, many people had the different view about this acquisition.

“Like Verwaayen, Julian Hewitt, chief analyst with Ovum, views the acquisition as a positive move for BT. BT's Global Services unit and Infonet lacked adequate scale to operate as a genuinely global network player, he wrote in a research report. Together they could create enough synergies to become one.” (1)

On the other hand, after the announcement on Monday, the shares in BT went down 2.34% at $3.48 on the London Stock Exchange. Infonet shares fell 7% to $2.00 in morning trading on the New York Stock Exchange. This move will bring more difficulties to make the combination work, plus the deal was made based on the cash sales, and concerns with the debts BT own before, the shareholders of BT may worry about that, it will lead a reduction of return on cash to them. Indeed, they will lose confidences and ask for more dividends, which will make BT harder on the cash flow.

Dollar against Pound Sterling

Based on the current exchange rate, the dollar is at record lows against the pound sterling, which is comes out at $1.83. Therefore, it made American companies worth less with a declining dollar. From this point of view, BT took the advantage, and made the acquisition easier and cheaper for them. However, nobody knows whether this kindness will bring success to the combination.

Financial Aspect

Although, there are some uncertain aspects about this combination, but BT still got positive view with it. BT plans to have significant cost savings from combining the two businesses. The saving will come from the reduction in annual cash costs of the combined businesses, and have cash synergies by $150 million (£80 million) in the third year following the acquisition. Then annual cash costs can be the elimination of overlapping network leasing, operating and maintenance costs, the reduction of Infonet's in-country access costs through BT's scale and purchasing power, and the generation of efficiencies in sales costs, administrative functions and back-office operations.

Synergy can be defined as “The two firms together are worth more than the value of the firms apart.” (Arnold, 2002, P. 872)

Infonet's net cash balance as at 31 March 2004 of $390m (£210m), the offered price represents a premium of 23% to the average price per Infonet share over the past three months of $1.68, and its net tax asset of £100m will add further value. Infonet has reported average annual growth in core revenues of 11% over the past two years to $620m in 2003/04, so it has indicated that it expects to be cash flow positive by the end of the current financial year.

On the other hand, BT expects the transaction to be cash flow-neutral in the first year and positive thereafter, after financing costs but before restructuring costs. It will be dilutive to net earnings by around 0.5% share in the first year but will increase BT's earnings per share thereafter. (3)

Benefits

“The increasing internationalisation of commerce has led to mergers between firms in different countries.” (McLaney, 2002, P. 335)

Infonet Services Corporation, known for its quality of service, global reach and customer base and all their strengths will complement BT’s strengths in the managed network services market. That is also one of the motives for this acquisition: combining complementary resources. It can be defined as: two firms can absorb/take advantages from each other to minimize or filling of own disadvantages.

BT Global Services CEO Andy Green added: “Infonet brings us specialist skills, a great customer base, increased global reach and additional local presence where we need it. By combining the strengths of both companies, we will substantially improve our ability to help our new and existing customers address the challenges and opportunities of the digital networked economy.” (2) Moreover, it also greatly extends BT’s global reach and will deepen the company’s presence in North America and Asia Pacific.

In addition, Jose A. Collazo, Infonet chief executive, commented: “This transaction is great news for Infonet’s customers, employees and partners. Our combination with BT will improve our ability to supply mission-critical services to our customers, by bringing a commitment to the long term development of IP-based services backed by financial strength and true global scale. While continuing to take full advantage of our existing services and delivery platform, our customers will also be able to access the whole breadth of BT’s product and solutions capabilities.”(2)

Conclusion

“Neither BT Global Services nor Infonet has adequate scale as a genuinely global networking player. Both organisations have been loss making, but together they should have sufficient scale to generate a profit when the synergies kick in. It seems that they both realized this point and doing the right thing according to the tending of the market. ” (3)

However, the right choice of the tending does not guarantee the success. To be successful, the combined company will have to effectively integrate and rationalize back-office systems and service portfolios, which also must be essentially transparent to customers. After the discussion above, the priced looked sensible, and those two companies can get great benefits from this move.