Here is the Smartalk Story in a nutshell
Pint-Sized Deal Gave AT&T a Barrel's Worth of Challenges
By SETH SCHIESEL
Published: Monday, January 25, 1999
When it comes to big deals, the AT&T Corporation can move fast. It's the small ones that can take time.
Shortly after AT&T announced last June that it would acquire Tele-Communications Inc. for $31.8 billion in one of the most complicated communications takeovers in history, for example, AT&T's chairman proudly pointed out that the pact had come together in less than two weeks.
So why did it take four months for AT&T to put together last week's $192.5 million agreement to acquire most of Smartalk Teleservices Inc., a small, distressed seller of long-distance calling cards?
The answer illuminates the world of mergers, the power of AT&T and the crushing difficulty of being a small communications company richer in concepts than in capital.
Last Tuesday, Smartalk issued one of the telecommunications industry's stranger news releases. Smartalk had agreed to sell its assets to AT&T for an amount that was barely more than one day's revenue for the long-distance giant.
Then came the odd part. ''Separately today,'' the release continued, Smartalk had filed for protection under Chapter 11 of the bankruptcy laws.
But there was nothing separate about the two events -- AT&T's buying a company even as it was filing for bankruptcy. Although AT&T and Smartalk declined to comment on their deal, court documents and executives close to the transaction indicated that it was the merger negotiations with AT&T that prompted Smartalk to file for bankruptcy, thereby allowing AT&T to acquire Smartalk's assets while avoiding its liabilities.
But this is not a case of a giant stomping a flea. Smartalk was on its last financial leg, and it had largely crippled itself.
Founded by Robert H. Lorsch, a former marketing executive, in Los Angeles in 1995, Smartalk was one of the first companies to mine the market for prepaid calling cards. The concept was simple: sell cards enabling people to make long-distance calls from pay phones, for a flat per-minute fee. Smartalk bought the long-distance minutes in bulk from MCI and other carriers and then sold them to consumers for a profit.
The business took off, Smartalk went public the following year, and by 1997 Mr. Lorsch was boasting in an article in Los Angeles Business Journal: ''I put $5,000 in the bank in October 1994 and now have a company with almost a quarter-of-a-billion-dollar market cap. That is a growth story.''
Whether from confidence or hubris, Smartalk went on to acquire nine other companies in little more than a year, giving it a 25 percent share of the prepaid calling card market.
But Mr. Lorsch was no Bernard J. Ebbers, the communications takeover wizard who built deal upon deal and is now chief executive of MCI Worldcom Inc. Smartalk was consumed by its acquisitions, failing to integrate its various financial systems successfully, according to executives close to the company. And since the company did not own its own long-distance network, it had difficulty controlling costs.
Then came perhaps the worst embarrassment a public company can face: the need to restate earnings.
Last August, the company said it would have to restate its financial results for all of 1997, after revealing that PricewaterhouseCoopers, the accounting giant, had uncovered potential problems in the way the company accounted for its acquisitions. That disclosure damaged Smartalk's credibility and essentially destroyed the company's ability to raise money.
So in September Smartalk entered negotiations to be acquired by AT&T.
The more AT&T looked into Smartalk's books, though, the more problems it uncovered, according to executives close to the deal. Some of those executives even questioned whether AT&T would have been willing to begin talks with Smartalk if it had realized what it was getting into.
Then Smartalk discovered that its financial reporting problems were not over. On Jan. 9, the company announced that accounting issues would cause it to restate its earnings for the third quarter to reflect lower revenue and higher expenses than it had previously reported. This additional bit of bad news clinched AT&T's decision that it would not acquire the company unless Smartalk filed for bankruptcy, according to executives close to the deal.
With Smartalk filing for Chapter 11, AT&T could acquire the good things about the company -- its retail distribution arrangements with prestigious clients like American Express and the United States Postal Service -- while letting the bankruptcy court decide what to do with the more than $200 million in debts.
As in most bankruptcies, the creditors will probably suffer. Executives at one of the long-distance companies to which Smartalk is indebted say they are not expecting to get more than about 70 percent of their money. Those holding Smartalk's $150 million in bonds may get less than that.
Smartalk's stockholders are already essentially wiped out. After trading as high as $36.50 last March, the company's stock has consistently traded below $3 this month. On Tuesday, the last day the shares traded, they closed below $2.
Some executives close to the agreement said that as recently as last summer Smartalk might have fetched as much as $750 million.
Of course, it is possible that another company could yet trump AT&T's offer. Now that Smartalk has filed for Chapter 11, a bankruptcy court is expected to hold an open auction for the company.
Any additional bids would start somewhere north of $192.5 million.
