WorldCom History

WorldCom appeared to be a great success story. In 1983 partners led by former basketball coach Bernard Ebbers, sketched out their idea for a long distance company on a napkin in a coffee shop in Hattiesburg, MS. Their company LDDS (Long Distance Discount Service) began providing service as a long distance reseller in 1984. For 15 years it grew quickly through acquisitions and mergers. Bernard Ebbers was named CEO in 1985 and the company went public in Aug. 1989. Its $40 billion merger with MCI in 1998 was the largest in history at the time. The company was a favorite with investors and Wall Street analysts. The stock ran up to a peak of $64.51 in June 1999. At that time CEO Bernard Ebbers was listed by Forbes as one of the richest men in the US. Michael Jordan, the most popular athlete in the world, provided commercial endorsements. In October 1999, WorldCom attempted to purchase Sprint in a stock buyout for $129 billion in stock and debt. The deal was vetoed by the Department of Justice. At the same time, the success began to unravel with the accumulation of debt and expenses, the fall of the stock market, long distance rates and revenue. It would tale 2 years for extent of these problems to become public. WorldCom's 2002 has been a horror story with accounting scandals, SEC investigations, the resignation of CEO Bernard Ebbers, possible bankruptcy and a stock that is worth less than a payphone call.

WorldCom Finances
Even before the recent accounting disclosures, by 2001, WorldCom was already going through financial turmoil due to large debt and declining rates and revenue. Growth in the telecommunications industry was slowing and the company had too much network capacity. The company was deep in debt from an ambitious buying spree. There were also the controversial $408 million loans to CEO Bernie Ebbers to cover his margin calls on loans secured by company stock. The accounting irregularities were discovered by an MCI internal auditor during a review of the books. The company then alerted the SEC. WorldCom currently does not have the cash to pay the approximately $5.75 billion in debt that will come due next year. It was originally seeking a $5 billion loan package. Now they are looking to secure $3b in loans. They hope that this loan plus cost cutting measures will help it meet interest payments and delay bankruptcy. A credit agreement between WorldCom and 26 banks was signed in July 2001. The company was to borrow, repay and borrow $2.65 billion within a year. The banks claim that 6 weeks before revealing the accounting disclosures, WorldCom told the lenders it was tapping into the entire amounts. The banks say that if they had known the true financial picture, they would not have extended the financing without demanding collateral. WorldCom needs this money to cover daily operations or will be faced with bankruptcy. WorldCom also has $30 billion in bond debt. The market value of the bond debt is currently about $4.5 billion. It lists $104 billion in assets but the real value of the assets is probably much less. Its market capitalization was once $120 billion in the summer of 1991. Currently it is close to $408 million. It has approximately $40 billion in property, equipment, etc. WorldCom's 2001 revenue was $35.2 billion. The projected free cash flow for 2003 is only $1.25 billion. This does not take into the account the loss of consumer and corporate business. WorldCom does have valuable assets. It has the world's largest internet backbone, thousands of profitable government contracts and 20 million customers. IDT, a long distance carrier, has publicly offered $5 billion for WorldCom's MCI consumer and small business long distance.

Accounting Fraud
WorldCom improperly booked $3.8 billion as capital expenditures, boosting cash flow and profit over the past 5 quarters. This disguised the actual net loss for 2001 and the first quarter of 2002. It is possible that the accounting irregularities go back to 2000. In simple terms WorldCom did not account for expenses when it incurred them, but hid the expenses by pushing them into the future, giving the appearance of spending less and therefore making more money. This apparent profitability pleased investors who pushed the stock up to a high of $64.51 in June 1999.

Effect On Consumers
With 20 million long distance customers, MCI is the second largest long distance carrier. Even if MCI declares bankruptcy, MCI will still be able to provide long distance service while it reorganizes. Whatever happens to MCI after bankruptcy, it will have to give the FCC a 30 day warning before cutting any service. This will give consumers time to find another long distance carrier.

Consumers can also expect a noticeable difference in customer with longer customer service call times and slower complaint resolution. Over the years, aggressive competition has driven down long distance rates; however, the remaining large carriers will probably take the opportunity to increase consumer rates and fees. Consumers looking to switch carriers will have to shop around for low long distance rates. SaveOnPhone provides and unbiased review and scoring system of carriers with the lowest rates and fees. Its rate calculator instantly ranks the lowest rate plans based on individual calling needs. Discount carriers have rates as low as 3.9 cpm.

Effect On Corporate Accounts

WorldCom's 20 million customers include many Wall Street powerhouses, large manufacturers and government agencies. It is likely that many companies will suffer one way or another from WorldCom's problems. Businesses which rely on data networks could be the ones hurt the most. Some of WorldCom Inc.'s big corporate customers are searching for new suppliers for systems that transmit company data internally and to business partners and customers. A full-scale switch can take months, depending on the complexity of a system. So far, WorldCom claims that it has not seen an exodus of corporate clients. CEO John Sidgmore is personally contacting corporate clients and rallying the sales force. Going after new accounts will be extraordinarily difficult due to the massive problems plus layoffs that included the sales force. Competitors are taking advantage and subtly pursuing WorldCom customers. Many corporate clients are locked into lengthy contracts with WorldCom that contain large penalties for switching, even if WorldCom files for bankruptcy reorganization. Many companies may be forced to choose between paying a steep fee for breaking the contract or let their vital communication networks deteriorate. About 20 percent of the big corporate customers are fortunate to have escape clauses in their WorldCom contracts that allow them to discontinue service if WorldCom's financial condition slides past a certain point. However, many will likely to hang in for the length of the contract because penalties for breaking the contract can run as high as 50 percent of the cost of staying in the contract. Corporate clients could be entangled if WorldCom does go to bankruptcy court, since legal rules could make moving to another service provider even more complicated. Therefore, those customers that could be looking for ways to get out as soon as possible. Corporate customers are already experiencing a slowdown and drop in service from WorldCom, which is laying off 17,000 workers, analysts said. The company already laid off 3,700 workers earlier this year.

Effect On Investors
There is not much hope for stockholders looking to recoup lost investments. Stockholders legally would have the right to some money, but in most situations they are at the bottom of the list and get nothing. MCI stockholders can't even console themselves with a dividend payment. WorldCom said Thursday it won't pay the final $.60 dividend on its MCI Group tracking stock in light of the carrier's precarious financial health, saving the company $71 million. Last year, the carrier created a separate "tracking" stock for its declining MCI consumer long-distance business in hopes of isolating that unit from WorldCom's seemingly stronger data, Internet and international operations. In May, WorldCom announced the elimination of the MCI tracking stock and suspension of its dividend, a move the company said would save about $284 million a year. WorldCom was recently delisted from the NASDAQ Stock Market. Delisting could force institutional investors out of the stock and make it more difficult for the company to raise cash through future stock offerings. This could also scare off corporate accounts. If WorldCom declares Chapter 11 bankruptcy, bondholders should not expect to receive interest and principal payments and shareholders will not receive dividends. Bondholders may receive new stock in exchange for bonds, new bonds, or a combination of stocks and bonds. The majority of bondholders are banks' investment departments, insurance companies and pension funds. Stockholders may be asked to send back their current stock in exchange for shares in the reorganized company. New shares may be fewer and worth less. The worst case is if stockholders' shares are declared worthless because the company is declared insolvent. The IRS can provide information about reporting worthless stock as a loss on income tax statements.

Effect On Internet Users

Less attention has been given to WorldCom's internet service, UUNet. WorldCom merged with UUNet in 1998. UUNet, is one of the Internet's primary backbone providers. It controls the wires that Internet service providers use as superhighways to carry Internet traffic between cities and across continents. UUNet handles more than 40 percent of U.S. Internet traffic, including a majority of e-mails sent within the United States and in the world. With KPNQwest in Europe, it handles over half of European traffic as well. Thousands of companies in over 100 countries rely on WorldCom for Internet access, including the Defense Department and the State Department. The potential of the loss off UUNet is disastrous and analysts predict that governments and companies wouldn't let UUNet die. However, worldwide layoffs at WorldCom could lead to problems such as slower connections as fewer employees are available to maintain the network.

Bankruptcy
It is widely expected that WorldCom will soon file for Chapter 11 Bankruptcy. Banks are pressing for Chapter 11 bankruptcy because the banks that provide the loans will be the first to collect payments. The $2.6 billion loan WorldCom recently received from 27 banks is unsecured, meaning the lenders would have a claim on WorldCom's assets in the event of a bankruptcy filing. Without bankruptcy, the banks do not have collateral on the loans they have already given. The banks would want to lend the company more money to keep it functioning, expecting the company to eventually be able to repay them. Banks will also have first shot at WorldCom's assets if it does go under. The benefit of bankruptcy for WorldCom is that employees get paid, customers get service, WorldCom retains possession of assets and a little breathing room to reorganize. Banks that provide the loans are in favor because they will be first in line to be repaid. If Chapter 11 is successful, WorldCom can continue to operate with a restricted debt load, operate more efficiently than before and preserve jobs and assets. If WorldCom declares bankruptcy, it will lose credibility and many large corporate and government clients that typically do not do business with companies in Chapter 11. If Chapter 11 is not successful, the next step is shutting down and liquidating assets. Analyst do not believe WorldCom's system will be allowed to go under, since it would cause havoc for the Internet backbone as well as long distance users. If WorldCom enters bankruptcy proceedings, it likely will emerge debt-free or sell its networks to other vendors. Typically in Chapter 11 bankruptcy, the U.S. Trustee will appoint one or more committees to represent stockholders and creditors to work with the company to develop a reorganization plan. The plan is voted on by creditors, bondholders and stockholders, and then confirmed by the court. Even if they vote to reject the plan, the court can still approve the plan if it treats stockholders and creditors fairly. The plan must comply with Bankruptcy Code. Confirmation could take several months. Management continues to run daily operations but significant business decisions must be approved by the court. Unfortunately, the 17,000 WorldCom employees who have lost jobs and retirement funds could also lose during bankruptcy. Severance is typically paid in a lump sum. WorldCom has elected to spread it out into multiple payments. If the company files bankruptcy before paying severance packages, employees will be bumped to the back of the line with other low-ranking creditors and could possibly see their severance capped. The company is possibly delaying these payments to conserve cash.

Telecom Industry Problems

The problems began with the 1996 Telecommunications Act which was supposed to open the door for competition, also opened the door for the problems that are coming out today. The law let long distance companies and Bells compete in each other's markets. Hundreds of competitors sprang up, borrowing heavily to finance their growth. Many of these have filed bankruptcy. FCC Chairman Michael Powell says the FCC may have made a mistake by encouraging the formation of these competitors without realizing how few would be able to survive. He said one way out for the industry could be a major consolidation such as the defense industry went through in the 1990's. He even suggested his agency would consider a Baby Bell to take over WorldCom. This may be an appealing purchase for a Bell, but it will be expensive and full of regulatory hurdles. During the race to borrow and grow, telecommunications companies overbuilt capacity. Currently only 10% of the 39 million miles of fiber-optic cables stretched out under the US are in use.

Presidential Response
Congress has already held hearings and wailed at WorldCom executives. They are promising business reform and more regulations. They are looking for ways to protect 401k participants and investors. President Bush is pushing for a full investigation. He described the WorldCom accounting scandal as "outrageous." The White House is reviewing federal contracts with WorldCom and has recommended barring future deals with the company. However, FCC Chairman Michael Powell cautions against "adding to the circumstances that might collapse the company." The President is calling for corporate responsibility, tough law enforcement and stiff penalties. He is in favor of an independent regulatory board for accountants, disciplinary bodies and analysts. Bush has proposed tough penalties including jail time for those who are deceptive with financial statements.

Who Is To Blame?
Naturally no one is stepping up to take the blame. WorldCom blames auditor Arthur Andersen for not uncovering the irregularities. Andersen claims they did not know about the improper accounting. They say former CFO Scott Sullivan never told the firm about the dubious accounting. So far, Sullivan and former CEO Bernard Ebbers have basically pleaded the fifth and remained silent. Ebbers states he has done nothing fraudulent and has nothing to hide. Sullivan told WorldCom lawyers that Ebbers did know of the money shifted into the capital expenditure accounts. John Sidgmore, current President and CEO, blames the former management for the company's problems. Wall Street Analyst Jack Grubman, who gave high favor to the stock, has admitted he rated the stock to high for too long. He insists he was unaware of the company's true financial shape.