On Wall Street, Bernard J. Ebbers enjoyed his reputation as the "telecom cowboy," the cocksure executive who successfully lassoed more than 70 acquisitions to build WorldCom (WCOM) into the nation's second-largest telecommunications company. But behind the scenes, Ebbers never made a move without the approval of Scott D. Sullivan, an accounting whiz kid who served as WorldCom's chief financial officer.
Over the years, as Wall Street bankers and WorldCom's own managers pitched deal after deal to Ebbers at his favorite barbecue joint near WorldCom's Jackson (Miss.) headquarters, Ebbers always deferred to Sullivan to "see if the numbers work." Even after Ebbers was unceremoniously ousted in late April as WorldCom's financial problems mounted, Sullivan was given a promotion by incoming CEO John W. Sidgmore as the best hope for persuading bankers to refinance the company's groaning debt burden. "After Ebbers left, Sullivan was the only one who understood the company's finances inside and out," recalls one WorldCom senior executive.
In the end, Sullivan's aggressive financial maneuvers could prove to be WorldCom's downfall. The company's disclosure late on June 25 that it had uncovered more than $3.8 billion in accounting irregularities puts WorldCom in violation of some debt covenants. The news, and the Securities & Exchange Commission's filing of fraud charges against the company a day later, will likely put an end to any hope Sidgmore had of pulling the troubled telecom giant out of its financial death spiral.
"TIP OF THE ICEBERG." And there may still be more skeletons in the closet: Sources close to WorldCom say internal auditors are uncovering further troubles. They include double-counting of revenue as far back as 1999, debt that may not have been previously disclosed, and booking of revenues that haven't yet been received from long-term contracts -- issues that could push the ultimate restatement to $5 billion or more. "What we're seeing may be the tip of the iceberg," says Susan Kalla, a telecom analyst at Friedman, Billings & Ramsey.
For his part, Sidgmore remains hopeful he can turn WorldCom around, assuring employees in a June 26 e-mail that "there is absolutely no impact to our company's cash position for 2001 and 2002. We continue to have significant cash on hand." In reality, a WorldCom bankruptcy -- which could eclipse that of Enron as the largest corporate failure ever -- suddenly seems inevitable.
"It will be real tough to keep the holding company out of bankruptcy," said one WorldCom banker. As a result, WorldCom's best hope may be to, like Enron, remake itself into a smaller company, focused on providing data and Internet service to large companies worldwide.
"COMMITTED TO CHANGE." That may depend on Sidgmore remaining above the fray. Both he and Ebbers, along with Sullivan and other execs, are being investigated by the SEC. If it turns out that Sidgmore, who was vice-chairman during 2001, knew what was going on, or that he rubber-stamped Sullivan's accounting, he too could be forced out. Sidgmore declined comment, but released a statement saying, "I have committed to driving fundamental change at WorldCom, and this matter will not deter the management team." Neither Ebbers nor Sullivan could be reached for comment.
In the near term, WorldCom's woes may spell opportunity for the rest of the industry, as rivals like AT&T (T) and Sprint (FON) scramble to steal WorldCom customers (see BW Online, 6/27/02, "Is WorldCom Opening a Door for AT&T?"). "The message we're getting from management is 'We've got WorldCom on the mat. It's time to kick them,'" boasts one sales rep at AT&T, which reacted with offers of broad discounts to such WorldCom customers as R.J. Reynolds Tobacco.
In the long term, the WorldCom scandal may force a fundamental restructuring of the telecom industry. Bernie Ebbers was more than just another telecom executive. He came to represent the competitive industry that sprang up in the 1980s and 1990s to take on the old Ma Bell monopoly. Now, WorldCom's collapse could spell trouble for those few remaining upstarts.
BELLS LEFT STANDING. Analysts fear that financing could dry up, lenders may begin calling in loans to other phone companies, and asset prices could plunge as WorldCom joins the long list of companies dumping properties. Scott Cleland, president of the Precursor Group, says 24 of the 29 telecom firms he tracks are already technically at risk of bankruptcy. WorldCom's woes are "creating a suction that pulls others into the abyss."
That could spell the death of telecom competition. The regional Bell operators may be the only large players to emerge from the current fiasco in solid financial shape. As newcomers collapse for lack of funding, and WorldCom is forced into a fire sale to raise cash, the Bells may be able to buy some of WorldCom's plum assets for pennies on the dollar. Some analysts expect them to eventually acquire AT&T and Sprint, too. If that occurs, the Bells will end up with nearly complete control of many communications services.
And WorldCom's troubles will ripple far beyond telecoms. Banks and hedge funds have scooped up its bonds, betting that its business is healthy enough to give them a solid return even if its stock continues to fall. But the accounting scandal hammered WorldCom bondholders. On June 26, its bonds plummeted 73%, to trade between 12 cents and 15 cents on the dollar. "Telecom bonds have been in trouble for some time, and it looks like they will continue to be," says Gina Haas, a spokesperson for High Yield Advantage Data.
NO. 5 NO MORE. It wasn't supposed to end this way for WorldCom. Despite Ebbers' image as a wheeler-dealer, analysts had always viewed WorldCom as a cut above go-go rivals such as Qwest International and Global Crossing Holdings. Their business models required investors to bet that the huge upfront outlays required to gain scale would eventually lead to big profits. WorldCom, by contrast, already possessed a stable of real assets such as MCI as well as blue-chip customers such as Nasdaq and AOL Time Warner. When its market capitalization peaked at $115 billion in 1999, WorldCom was the fifth most widely held stock in the country.
Now, the allegations of fraud are calling into question WorldCom's earlier performance. Simon Flannery, a telecom analyst at Morgan Stanley, estimates that as a result of the restatement, WorldCom's operating margin is just 16.8% -- a fraction of the 30%-plus margins it boasted as recently as 2000, and the 21% it still claimed prior to the disclosure. Investors now wonder whether WorldCom's outsized profits in the 1990s were nothing more than accounting fiction. WorldCom "was a momentum-growth scam," says Cleland.
At the center of the storm is Sullivan. A graduate of the State University of New York at Oswego, he signed on to KPMG's Albany office in 1983, where he saw the mergers and acquisitions game firsthand while helping to audit the General Electric account. Sullivan showed up on Ebbers' radar in 1992, when WorldCom acquired Advanced Telecommunications, a small long-distance provider in Atlanta where Sullivan was then serving as CFO. Ebbers quickly promoted Sullivan through the ranks, and named him WorldCom's CFO in 1994.
THE LAST STRAW. As popular as he was with Ebbers, Sullivan quickly rankled division managers by sending junior accountants to double-check their books, which the managers viewed as unnecessary and demeaning. Over time, some division managers began to suspect that Sullivan -- with Ebbers' support -- was increasingly pushing the envelope with his hyperaggressive accounting. "We'd send in one set of numbers and then see different numbers in the final financial reports," says one executive in WorldCom's MCI division who recently left. "No one would listen to us when we complained."
Now, it appears that Sullivan's accounting may prove to be the last straw for WorldCom. After Sidgmore took the helm in April, he ordered a sweeping assessment of WorldCom's businesses -- including a thorough examination of the company's books -- as part of a 30-day review that he hoped would rebuild momentum at WorldCom. But questions were already starting to build. According to WorldCom insiders, the company's lenders began to conclude its financial picture was even worse than imagined.
As they reviewed the books in preparation for tough negotiations over new financing, the bankers began to find that some of WorldCom's myriad divisions and subsidiaries were holding debt that hadn't been consolidated on the company's balance sheet. When they confronted Sullivan about it, they were troubled by his answers -- and negotiations slowed sharply. "The banks began to see Sullivan as shady," says an executive who has talked with members of WorldCom's internal auditing team.
A BOMBSHELL. The real shocker came in early June. One of Sidgmore's auditors found that WorldCom had booked some ordinary expenses as capital investments -- a move that enabled it to spread those outlays over many years, and thus made it appear profitable in 2001 and the first quarter of 2002, when it wasn't. WorldCom pointed out the discrepancies to investigators from the SEC, who were in the midst of their own probe of WorldCom's accounting.
As a result, on June 25, WorldCom dropped the bombshell -- along with news it had fired Sullivan and that the company's controller, David Myers, has resigned. And with that, WorldCom's once-mighty empire may be remembered as a mirage. By Charles Haddad and Dean Foust in Atlanta and Steve Rosenbush in New York, with bureau reports