SBC Puts Williams in a Pickle

Williams Communications Inc. was in a pickle this fall. The wholesale long-haul provider was hoping to emerge from bankruptcy court this fall, but its largest and most important customer, SBC Communications Inc., was seeking the legal authority to terminate or alter a Master Alliance Agreement.

The modification or dissolution of the agreement would give SBC, the No. 2 local phone company, the right to haul its long-distance traffic over other networks, which could jeopardize the future of Williams Communications.

SBC serves 4.3 million long-distance customers using the backbone network and software of Williams Communications, comprising approximately 34 percent of the company’s $1.185 billion in revenue in 2001.

Williams Communications announced in late July it was on target to emerge from bankruptcy by Oct. 15 after reaching an agreement to secure a $150 million investment through New York-based diversified holding company, Leucadia National Corp. However, the agreement with Leucadia could fall apart if the Master Alliance Agreement is broken.

SBC argues that when Williams Communications spun off from its energy company, The Williams Companies, in April 2001, the spin-off represented a change in control. Under the Master Alliance Agreement between SBC and Williams Communications, SBC has the ability to terminate or modify the 20-year agreement if a change in control takes effect.

Williams Communications denies that the spin-off represented a change in control. "WCL [Williams Communications LLC, the operating company] is and was owned, in its entirety, by the debtor, WCG [Williams Communications Group, the company that filed for bankruptcy last April], the company said in a court filing. "Thus no direct ownership changed as a result of the spin-off.”

Williams Communications said in court filings an SBC representative sitting on the company’s audit committee board even approved the spin-off: Ross Ireland, who was appointed by SBC, along with two other audit committee members, voted in favor of the spin-off March 26, 2001, recommending it to the entire board of directors of Williams Communications. Moreover, SBC had 180 days under the MAA agreement to reserve its right to claim that the spin-off represented a change in control, but the company took no action, according to Williams Communications.

SBC retorts that neither Ireland nor anyone else representing SBC agreed to the spin-off. “SBC did not grant consent to the spin-off at any point in time,” the company said in a court filing.

A court hearing to consider whether the spin-off constituted a change of control was delayed. The matter could be taken up the date of confirmation of the reorganization plan scheduled for Sept. 25. In late August a temporary restraining order was issued, preventing SBC from taking any steps to terminate the Master Alliance Agreement.

"This is not impacting our day-to-day operations," a Williams Communications spokeswoman said.

Frost & Sullivan analyst Rod Woodward said SBC’s actions don’t necessarily mean the company wants to sever its ties with Williams Communications, but merely give itself more flexibility. "If you are SBC, you have to understand they are covering their bases as well," he said. "I think they are just being cautious and understandably so.”

Williams Communications tailored the design of its network largely to the needs of SBC, underscoring SBC’s heavy reliance on its partner to serve its long-distance customers, according to court filings. In fact SBC cannot provide service to those customers or bill them without Williams Communications, and it would take a year to 18 months for SBC to have the capability to restore service to those customers if Williams Communications were to shut down the network, according to court documents filed by SBC.

To avoid such a doomsday scenario, SBC said in court filings it submitted proposals to Williams Communications in order to ensure service continuity: SBC would buy switches and license the software from Williams; SBC would license the software with the option to buy the switches and provide for the creation of a backup data center; SBC would have the option to license software and the option to buy switches and provide for a backup data center. The most recent proposal included moving 10 percent of long-distance traffic off the Williams Communications network. Williams Communications has rejected all the proposals, according to SBC.

SBC told the court it began to fear potential network disruption in February when Williams Communications CEO Howard Janzen began to threaten a possible bankruptcy filing.

“Mr. Janzen told SBC that SBC did not know what it was facing if it could not come to terms with WCG and threatened that service to SBC’s customers could be cut off in a bankruptcy proceeding,” the SBC documents said.

Williams Communications filed for Chapter 11 bankruptcy-court protection in April. Despite several consecutive quarters of network services growth, last year the company posted a net loss of $3.8 billion, or $7.86 per share, and wrote down the value of its assets by $2.9 billion.

Under an amended reorganization plan, Williams Communications would eradicate approximately $6.5 billion in claims and emerge from bankruptcy with around $525 million in debt, far less than its rival Level 3 Communications Inc., which has not filed for bankruptcy. Leucadia would invest $150 million in the company and fork over $180 million to settle the claims of The Williams Companies against Williams Communications.

If the Master Alliance Agreement is broken, however, the reorganization plans of Williams Communications could collapse. "As this court already has found the MAA ‘represents the single most valuable asset’ of WCG’s estate and Leucadia is the only ‘likely’ source of investment on terms that do not jeopardize the MAA," according to a Williams Communications court filing.