The Humongous Hookup

It was a highly personal kind of deal, done in a quiet hallway of a New York City hotel, man to man. The place was the Waldorf Astoria, and the players were Robert Allen, chairman of AT&T, and Craig McCaw, head of McCaw Cellular Communications. In the middle of an edgy negotiation, they had left their factotums, emissaries and lieutenants behind and paced the corridor together for just 20 minutes before shaking hands on a transaction in which the largest U.S. telephone company would buy the No. 1 provider of cellular service for $12.6 billion in stock. In the process, Craig McCaw would become a billionaire and his three brothers (Bruce, Keith and John Jr.) all centimillionaires.

The AT&T-McCaw merger, which ranks as the fifth largest in U.S. corporate history, raises the ante in an industry that is being radically reshaped by emerging technologies, falling regulatory barriers and a series of powerful partnerships and alliances. It comes only weeks after phone giant British Telecom spent $5.3 billion for a 20% stake in MCI Communications, the second largest U.S. provider of long-distance service, and it closely follows U S West's $2.5 billion investment in media conglomerate Time Warner. Although the merger is praised by consumer groups because it could lead to lower phone rates and innovative products, many analysts predict that it will ring up even more industry turmoil as it reduces the boundaries separating long-distance and local telephone service. It will also bring AT&T into close competition with local telephone carriers, including the seven former Bell System companies, collectively known as the Baby Bells.

"This is going to set off another round of deals as everybody scrambles to find a dancing partner," says Peter Huber, a telecommunications consultant in Washington. "Competitors cannot afford to let this powerful alliance go unanswered."

Together, AT&T and McCaw will give rivals plenty of reason to fret. They are expected to strengthen each other's hold on their respective markets. By linking its own computerized telephone grid with McCaw's advanced cellular network, AT&T is expected to develop a broad menu of customized services. It could, for instance, bundle telephone handsets, long-distance and cellular service in a single package. With AT&T, Craig McCaw moves one step closer to realizing his biggest dream: building the first nationwide cellular-telephone network.

The merger turned out to be the richest -- and luckiest -- deal in McCaw's life. The two companies had first spoken of the arrangement last November when AT&T agreed to acquire 33% of McCaw Cellular of Kirkland, Washington, for $3.8 billion. Negotiations stalled, however, over the issue of how to divvy up strategic decisions and future profits. The solution of buying all of McCaw, rather than just part of it, might not have been possible a few months ago. Fortune intervened, however, when the value of AT&T's stock rose 46%, or $26.5 billion, between November and two weeks ago. Since the purchase price would be in the form of AT&T stock, the telephone giant could afford to splurge.