Esrey: mega-merger propels global ambitions

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In October 1999 it was announced that the third biggest long-distance telco in the US, Sprint, would merge with MCI WorldCom, the number two player, in a transaction worth $129 billion. The new carrier, to be called WorldCom, will be a leading provider of global communications services. Sprint's chairman and CEO Bill Esrey talks to Mark Holmes about the merger.

Sprint built and operates the first nation-wide all-digital fibre-optic network in the US. It is also a leading player in advanced data communications services. The operator had been considered a merger/acquisition target for more than a year. In October 1997 Sprint announced that it was merging with MCI WorldCom in a transaction worth $129 billion ($115 billion in equity and $14 billion in preferred stock). This concluded a hectic round of activity, which saw BellSouth make a last ditch bid to merge with Sprint.

A number of analysts had referred to MCI WorldCom's need to acquire a wireless operator in the US with a national footprint. One of Sprint's most attractive assets was its wireless operation, Sprint PCS, which has almost one million subscribers.

Bruce Roberts, a telecoms equity analyst at Dresdner Kleinwort Benson, talks about the importance of Sprint's wireless strategy: "I think that wireless plays a very major role, as they have a nation-wide wireless network. There is a lot of bundling they are trying to do with long distance and wireless. So wireless is not only important in itself: it is also important as a bundled offering to strengthen their long-distance offering and market share and defend that market share when the RBOCs come in. So wireless is definitely a major piece of the bundle puzzle."

One of Sprint's other major assets is its nation-wide ATM-based ION network, which is recognized as one of the most advanced data networks in the US. Roberts talks about Sprint's data strategy: "I think that they (Sprint) are one of the major data players, as they have developed a very strong data network with an ATM backbone. They have one of the best networks out there. They are very efficient and reliable and they have a large proportion of business customers."

One of the other key elements of the merger is that it brings together two of the most dynamic management teams in the industry. Roberts talks about Sprint's management team: "I think that they have a very strong management team with a clear vision. They work as a consensus group and set out objectives that are realistic and well monitored and have clear objectives. They execute very well and have executed consistently." The combination of the two management teams should prove to be a significant asset. The new company will have 16 board members, with 10 from MCI WorldCom and six from Sprint. Bernard Ebbers will be the new president and CEO, while Esrey will be the new chairman.

In an exclusive interview, the chairman and CEO of Sprint Bill Esrey explains why Sprint decided to merge with MCI WorldCom and outlines how the new company will operate as one of the leading global telecoms service providers.

What are the reasons behind the merger? Why did you feel that this was the best deal for Sprint?

From Sprint's viewpoint, the merger follows from what we have said all along. We have devised a very effective strategy to create value for our shareholders. If we can find a better way to achieve that goal, we will always seize it. When we started looking at this transaction, we felt that there were a couple of areas in Sprint that could be strengthened.

There were also probably a couple of areas at WorldCom which could be strengthened. When we looked at the match, we realized how well WorldCom bolstered the areas that we needed to strengthen and probably vice-versa. So that was the motivation. It looked like an opportunity to move forward better, more rapidly and with a greater probability of success, by creating what will in our opinion be a pre-eminent telco, when you look at the fine resources of the two companies.

You mentioned a couple of areas where you felt that you were a bit weak. Which particular areas?

From Sprint's point of view, we had difficulties in our international strategy. While operationally GlobalOne is a very confined company doing quite well, the partners were not aligned at all. There have been very well publicized differences between France Telecom and Deutsche Telekom.

And so that partnership, from an ownership standpoint, needed restructuring. It was clear that the three partners could no longer remain owners. Something had to change.

We looked at WorldCom's achievements internationally, considering the strength of their international operations: what they have done building broadband metropolitan area networks both in Europe and Asia. We looked at that as a very strong, world-wide decision, where they have established in effect an "on net' base, where they can keep their traffic from origination to termination pretty much on their own network.

Secondly, from Sprint's point of view, in terms of access within the US we have on the whole been leasing the local access facilities of the RBOCs in major cities throughout the US, which is not a cost-effective way to deliver traffic. We were looking at massively building our own network in the US to offer competitive local service. WorldCom has done a very effective job owing to the past acquisitions of Brook's fibre and MFS and the facilities that they operate. As a result, Worldcom could completely resolve the issues that Sprint faced in both those cases.

On the other hand, WorldCom did not have an effective wireless strategy. With Sprint PCS we resolved that issue for them. In addition Sprint has ION, our Integrated On-demand Network, which is in my opinion very advanced - and certainly ahead of any competitors - and provides a very rational strategy for entering the local market.

As you know, local telephone service is provided in the US by local monopolies. These local markets are not open to competition. Our ION strategy is not only unique - we are probably several years ahead of any of our competitors. If you take ION and combine it with the local access capability provided by WorldCom, I think that together we make quite a powerful force to really go in and break open the door of the monopoly that exists in the US.

If I can continue on this area. MCI WorldCom displayed an interest in Nextel earlier in the year. Did you expect WorldCom to pursue Sprint, after the company had announced its interest in Nextel?

No, this is not about Sprint selling out per se or WorldCom coming after Sprint. As a matter of fact, when we saw the press reports stating that they were talking about Nextel, I called Bernie to suggest that there were perhaps other ways to adjust WorldCom's wireless strategy.

We had talked about a plan where they could actually become involved in Sprint PCS. That was the original basis for this contact. We were not trying to sell Sprint PCS: we were looking for a way for them to join forces, whereby Sprint PCS could grow even more rapidly by providing Worldcom with some air time or part of the frequency in an air interface on Sprint PCS. Other discussions ensued from that initial talk. We explored what would be involved in putting the two companies together.

How do you view the future for GlobalOne? Surely you will have to pull out?

Well, following the transaction with WorldCom, it is now clear that we ourselves are in conflict with GlobalOne, since WorldCom has in-country facilities in both France and Germany as well as in other places in Europe. I think that the three parents of GlobalOne all agree that one parent should buy the company and go forward.

If we can go back to the merger of your two companies. In your opinion what will be the company's competitive advantages? Which telcos do you consider to be your main competitors nationally and globally?

I think that if you look at the company's collection of assets and businesses, you will see that it is the best positioned in the fastest growing areas in the industry. One area where we will be well positioned is in international, both in terms of international traffic and facilities-based capabilities in Europe and Asia. I don't think that anyone has a wider capability in those assets, in terms of metropolitan networks in the world's major cities.

I think that if you look at data and IP, Sprint is very well positioned in data, as is WorldCom. In addition, WorldCom is exceedingly well positioned in the Internet and the IP areas. So that is a second area with tremendous growth. Wireless is a third area of growth.

Clearly the new company is extremely well positioned because of Sprint PCS, which is the fastest growing wireless company in the US. Sprint PCS has grown substantially faster quarter after quarter than any wireless competitor in the US, usually outselling its competitors by one and a half to one, and often as much as two to one.

Sprint PCS is the only company that has nation-wide licences in the US. It is the only company to deploy one technology - the CDMA technology - across the US. And CDMA technology is generally being adopted for next generation on a world-wide basis.

Finally, as I explained, owing to the potential that Sprint ION offers and WorldCom's local access capability in the US, the next real opportunity in the US is provided by the break-up of the local monopolies and the chance to offer local consumers for the first time a true competitive alternative to the existing monopoly Bell provider.

With ION you are not only offering services as just another competitor: you are providing a totally different capability with regards the types of services that are offered under ION. It is interesting to notice that I virtually did not even mention voice in response to your question, an area which is not really experiencing growth.

If we could now turn to the build-out of the ION network. How far have you advanced with the roll-out? How much are you spending on ION this year? When do you expect to offer ION services?

ION really constitutes a complete transformation of Sprint's nation-wide network. It comprises an ATM network and embodies the capability of providing a whole variety of services, whether it be voice, ATM, frame relay, X25. Instead of operating multiple networks, as we have done in the past and everybody else has been operating, we are using one network.

We can achieve great efficiencies in this way. The next step is: how do you take that network to the residential customers' premises and to large and small businesses. ION extends our nation-wide network right to the premises. This is not so hard in large businesses, as you directly connect off fibre rings right to the premises. In smaller businesses and residences, how do you get broadband to that last mile?

We can use different technologies, as ION is what I like to call "last mile agnostic". With ION, we can use cable television plant, DSL or fixed wireless. We are initially rolling out DSL technology. We will follow very quickly next year with fixed wireless under the MMDS frequencies.

Earlier this year Sprint bought about half the available MMDS frequencies in the industry. And WorldCom bought the other half. So together we have about 58 million of the 100 million households in the US under our licence and MMDS frequencies.

The ION roll-out is right on schedule: it is the same roll-out that we announced about a year and a half ago. We have large businesses up on ION now, on direct connect. We have begun to roll out to medium businesses. And we will start to roll out to residential customers by the end of the year, offering ION to the home initially in Denver, Seattle and Kansas City.

Could you tell us about your relationships with Cisco and Telcordia? Why did you decide to base the ION network on ATM technology?

We talked to all the major manufacturers. We obviously needed help to manufacture the equipment. We talked to all the suppliers. We opted for Cisco and Telcordia owing to the individual capabilities that each possesses. We use ATM for the simple reason that it is the only technology available that can handle all these different types of service at the quality that the customer demands.

ATM is the only technology today that can handle voice with what we would call total quality or the highest quality. Voice over IP suffers many problems in terms of quality and latency. In terms of our network, we are not religious zealots about ATM, IP or anything else.

I think that IP will continue to evolve to a state where it will be able to handle voice better. That will add some overhead to IP. I think that ATM will go in IP. You will probably end up with something in the middle. And we will be there. But right now we cannot provide the type of services at the cost we want, unless we use ATM, which can incorporate everything, whether it is data, video or voice, under one protocol.

Could you tell us about the roll-out of your DSL services? How do you view DSL providers such as Covad, Rhythms and Northpoint?

I think that if we had been talking about this a year ago, you would have found people questioning how fast DSL was really going to roll out. We were quite confident that it would roll out very rapidly, as there is a market. I would say two things about the DSL roll-out. With just DSL, what you have is basically sessions. You have a voice session and a data session, and you split. When you reach the end of the DSL in the central office, typically people send voice over the public switched network and data probably through the Internet.

With ION we use DSL, but then we take the DSL and convert it to an ATM stream right from the premises. Now we have created a pipe that we can allocate, depending on a customer's specific needs. We can have multiple phone calls, not just one voice session. We can have multiple data sessions. That can be dynamically allocated millisecond by millisecond with bandwidth going to wherever the customer needs it. Lastly, service can be designated. For instance, voice can be designated, so that it is never impinged upon and always maintains its high quality.

So we basically take DSL as a foundation and then use the ATM stream to put that premise right on our nation-wide backbone, rather than simply putting something through the central offices, pulling off a data session and a voice session. You are on the nation-wide Sprint network with ION and that capability.

There are about 25,000 central offices in the US. If you consider outfitting about 2,500 of those central offices, you have most of the addressable market for the people that are going to want high-speed data access multiple phone lines for a substantial amount of long distance, those type of users.

We look at the Northpoints, Covads, Rhythms and others, which are rapidly putting in DSL, as well as the RBOCs. Existing market prices are considerably higher than what we could offer, if we owned our own facilities. Again, owing to our knowledge and expertise from operating local telephone companies, we have a good understanding of the cost structure.

So we did not really want to build out our own DSLD-Slams, but were forced to do so to make the economics attractive. As a result, we are co-locating and building out D-Slams all over. I think that we will have installed 1,500 D-Slams by the end of next year. WorldCom is also doing quite a bit in this area. As there is not that much overlap, I think that the combination of the two companies will offer us a very broad DSL reach.

Then, as I mentioned earlier, you add the D-MMDS licences of the two companies to our DSL capabilities. Together we cover about 58 million of the 100 million households in the US. Based on our modelling, MMDS appears to be an even more cost-effective last mile strategy to connect the customer to the ION network than DSL.

When we spoke last year, you said that: "IP telephony is not nearly as cost effective as it first appears." You also noted: "IP as a protocol is not very effective in handling high-quality voice." Do you still believe that these opinions hold true?

Let me explain why I think that this is true. IP telephony is basically subsidized by the lack of any access costs. That is why I am saying that it is not as cost effective as it first appears. A voice call involves access payments. An Internet call does not involve access payments: when I say access payments, I mean payments to the local exchange company. The fact is, the identical facilities of the LEC are used, whether you make a toll voice call or an Internet call, but one has an associated access charge, while the other does not. So there is an artificial subsidy.

You know, it really goes both ways. There is an unofficial charge for the toll call that is higher than the cost. There is no charge for the Internet call which is obviously lower than the cost, but there is an imbalance between the two. That is one reason why you temporarily have an artificial cost distortion on the Internet, and therefore on IP telephony.

Secondly, you have the problems of quality of IP handling voice. It is getting better, but it is still inferior to a toll quality voice, unless you throw in loads of bandwidth. The ION strategy is to address all those problems and use the efficiency of packetizing everything: ATM packetizes that, but with a better voice quality for the voice side.

Do you believe that customers are reaping the benefits of these new broadband technologies?

In my opinion, while there has obviously been a huge delay and difficulty in getting broadband to the consumer, you will see that those walls are about to come tumbling down. AT&T, with its cable strategy, is bringing broadband into the residence of the consumer and so forth. Sprint is bringing - and Sprint and WorldCom will bring - broadband to the consumer with DSL and fixed wireless. Of course, you have the rapid build-out of DSL by companies such as Covad, Rhythm and Northpoint, which is bringing broadband partially into the home. I believe that this is also forcing the RBOCs to move along rapidly.

Do you see the paradigm shifting to wireless? How important is it to have a national footprint in wireless?

A national wireless footprint is a significant benefit for consumers. They want to have a wireless provider with a presence wherever they are, offering the same type of predictable charges, so that they don't have to wonder what the roaming charges are going to be when they are travelling, or be subjected to some kind of daily charge or something like that.

We are witnessing the initial shift of wireline minutes to wireless. This is happening more and more rapidly: people are using their wireless phone, not only as a substitute for the wireline phone; they are also using wireless for long-distance needs. Now, of course at Sprint we have rolled out data and Internet access, which is now available on a nation-wide basis. I think that while wireless is quite the buzz now, we will look back and see that we are just at the beginning.

How do you view the potential for wireless data applications?

I think that wireless data is going to be amazingly important. We are seeing very significant developments in wireless data. We rolled it out last month.

I have been using wireless data for a couple of months. It has already changed my behavioural patterns. This is interesting. About a month or so ago I was at a meeting in California - a regional review of our Sprint PCS operations in Southern California - and I noticed a guy with his PC open, who was taking notes during the meeting. At the end of the meeting, he sent an e-mail to his people with action items from the meeting.

At the end of the meeting I walked out of the building, got into a car and called my family who were driving to Sprint International, which is a golf tournament that we sponsor in Denver. My wife was driving with some Sprint PCS employees that had wireless access to e-mail. I called up and she said: "Gee, you had a great meeting". I replied: "How do you know?", because I had literally walked out of the meeting five minutes beforehand.

They said that they had received this e-mail with the notes of the meeting. I was a little bit confused, as I thought that they were driving into Denver. They said that they were on Interstate 70. They had the PC hooked up to a Sprint PCS phone and were receiving their e-mail. They had received the e-mail five minutes after the meeting, while going down Interstate 70 at about 70-75 miles an hour. That is the way the world is moving. I am in the business and even I sat back and said "Wow!"

As pricing margins are squeezed, how will you maintain revenue growth in this area? How many new customers do you expect to add this year? How much are you spending on the expansion of the wireless network?

We have been the fastest growing wireless provider in the US. Literally our PCS operation has grown from having virtually no customers two years ago to a situation today where we have well over four million. We will have way above five million customers by the end of the year.

The average revenue/subscriber has held at a fairly good level of about $54 a month. This number is higher than the figure for traditional cellular companies and indicates a real mix of high users and safety users. We are enthusiastic about the additional features and functions that are being added to the phones and the wireless network.

We expect to generate considerable additional revenue from new data capabilities. We continue to aggressively expand the network, not only build-out in terms of geographical reach: owing to traffic growth, we are constantly splitting the cells, which increases the quality. The more cells there are, the greater the penetration.

Why did you decide to form a broadband wireless group? Why did you decide to buy the first five wireless companies, People's Choice TV, American Telecasting, Transworld Telecommunications, Videotron US and WBS America? How do these acquisitions strengthen your competitive position?

They were all the MMDS licences I referred to as part of our ION strategy. It is another way to access the last mile and enter directly into homes and businesses. Those frequencies have generally been used for one-way traffic: for entertainment/TV. Now the FCC is changing and improving those frequencies for two-way communications. We will use them as a delivery method for reaching our subscribers and putting them on the ION product.

How do you view the recent decision by China Unicom to terminate all JVs with international carriers? Could you tell us about the blend of international assets between Sprint and MCI WorldCom?

Let me comment first of all on China Unicom and the issue of foreign investments: it was disappointing, as it is a change in the regulations. I think that there is an issue for China: how to resolve the awesome task of expanding their telecoms infrastructure and find a way to achieve this goal that is attractive to foreign investors and makes it worth their while spending their time, talent and resources to help implement that task. But there has got to be a fair return as a result.

I think that the international community looks at this as somewhat disappointing: you think that you have reached an understanding and you have a deal that was concluded with China Unicom, which is also part of the government. And then the rules subsequently change - that is a setback. I think that everybody is waiting for clarification on this issue.

As to Sprint and WorldCom going forward and the handling of our international traffic: you have to understand that our transaction requires regulatory approval before it is closed.

How do you view the events of the last couple of weeks? How significant is the merger for the overall future of Sprint?

Our main strategy can be summed up as follows: if we could find a way to create a more capable and more successful company going forward, we were going to seize that opportunity. That was the opportunity that we saw, which evolved from our discussions with WorldCom. That is why we were so pleased to be able to consummate that transaction. So it was really about strategy and how to make yourself more effective going forward.

If you look at the history of our company - it is the 100 year anniversary of our company - we have always hooked up with, acquired and supported other companies. This is the first time that we have been acquired by someone else, but in this case it involves two large companies coming together. Our employee base is almost the same. We have 70,000. They have about 72,000 employees. The shareholders in the new company will be split - about 55% WorldCom and 45% Sprint.

There has already been speculation from top industry analysts about your future. Do you see your long-term future with the new company?

Absolutely. I plan on it. I certainly don't consider my job to be over. This is not about selling out Sprint. This is about making it a more effective competitive company going forward, which is what we have done. Bernie is going to be CEO of the company. I am going to be chairman. I am very excited about what I will be doing there.

What are your hopes and ambitions for the new company over the next two-three years? In your opinion, how will all this consolidation affect the telecoms industry on a global scale?

Clearly when you look at the collection of assets and our positioning in the fastest growing parts of this industry, I think that you will find that almost all the innovations, as Bernie Ebbers has said in the telecoms industry, have come over the past few years out of Sprint and WorldCom, almost without exception. That is our opportunity going forward.

Our goal is to blend these companies and capabilities and lead the industry in the areas that are the most dynamic and the fastest growing: international, data, wireless and the newly evolving local competition. But we perceive that to be a challenge. If we can lead in both of those areas, we will have created a company that in my opinion delivers tremendous value to our customers in terms of new innovative products. I think that we will as a result be rewarded with outstanding growth and profitability.