What it means
The break-up followed a long antitrust case against AT&T, which at the time owned both long-distance service and almost all the local telephone lines in the United States. The settlement separated the long-distance business from the local networks, and those local networks were grouped into seven regional holding companies.
The press called them Baby Bells because the parent had long been nicknamed Ma Bell. The seven were Ameritech, Bell Atlantic, BellSouth, NYNEX, Pacific Telesis, Southwestern Bell and US West, each with a regional franchise on local lines.
They were valuable because local telephone access was a steady, regulated, cash-generating business. They were also constrained, because the settlement barred them for years from long-distance service and equipment manufacturing.
What makes the episode interesting for non-finance managers is the valuation lesson. Investors who held shares in the parent received shares in each of the seven successors, and the combined market value of the pieces went on to grow faster than most analysts had expected of the single company.
Breaking a conglomerate apart can release value simply because each piece is easier to understand, finance and manage. The structure did not last.
Once the rules were relaxed, the Baby Bells bought each other and eventually the long-distance business they had been separated from, consolidating into a small number of national carriers. That cycle, a break-up followed by reconsolidation, is common after a forced divestiture.
The term now does double duty. Analysts use Baby Bells literally when discussing telecommunications history, and loosely as a label for any proposed regional or divisional split of a dominant business, which is why it still appears in commentary on large technology and utility companies.
In practice
Real-world examples.
Example
A pension fund holding shares in a diversified utility argues at the annual meeting for a demerger of the regulated network from the retail supply arm. It cites the Baby Bells as evidence that separately listed pieces can be worth more than the whole.
Example
A competition regulator investigating a dominant rail operator considers structural separation of the track from the train services. The operator's finance team prepares a sum-of-the-parts model to show what each piece would be worth standing alone.
Example
An equity analyst covering a large technology platform publishes a note headed with a Baby Bells comparison. She models the business as three separately listed companies to estimate the value shareholders might receive if a break-up were ever ordered.
Formula
Calculation
Sum-of-the-parts analysis, the technique used to value a break-up, works as follows: value each division on the multiple that fits its own business, add the values together, subtract group debt, and compare the result with the parent's market value. Take an illustrative regulated group with three divisions. The local network division earns $600,000,000 of operating profit and comparable network companies trade at eight times operating profit, giving $4,800,000,000. The mobile division earns $250,000,000 and comparable mobile companies trade at twelve times, giving $3,000,000,000. The directory division earns $100,000,000 and trades at six times, giving $600,000,000. The sum of the parts is $4,800,000,000 plus $3,000,000,000 plus $600,000,000, which is $8,400,000,000. Subtract group debt of $1,400,000,000 and the implied equity value is $7,000,000,000. If the group's shares are worth only $5,600,000,000 in the market, the conglomerate discount is $1,400,000,000 divided by $7,000,000,000, which is 20%.Case study
Seen in the real world.
Meridian Telecom Group is an illustrative, fictional carrier used here to show the mechanics of a regional break-up. After a competition ruling, it was required to separate its five regional networks into independent listed companies, and shareholders received shares in each of them.
For the first two years the pieces behaved exactly as the fictional regulator had hoped. Each regional board cut central overhead, priced for its own market and invested in its own network. By year five, three of the five had merged back together, arguing that national scale was needed to fund fibre, and the group's shareholder register looked much as it had before.
The illustrative lesson is that structural separation changes incentives immediately and ownership only temporarily, which is why regulators pair divestiture orders with continuing merger review.
Watch out
Common mistakes.
- Believing the Baby Bells were new start-up companies, when each was handed an established regional network and customer base.
- Assuming a break-up automatically creates value, when duplicated head office costs and lost purchasing scale can offset the gain.
- Using the nickname as if it referred to one company rather than a group of seven separate regional holding companies.
Questions
People also ask.
Why were they called Baby Bells?
Because they were the regional offspring of the Bell System, whose parent company had long been nicknamed Ma Bell.
Do the Baby Bells still exist as seven separate companies?
No, they merged and consolidated over the following decades into a much smaller number of large carriers, some of which also absorbed the long-distance business.
What is the finance lesson from the break-up?
That a sum-of-the-parts valuation can reveal a conglomerate discount, meaning the market values the whole at less than the pieces would fetch separately.
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