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At MCI, The Worst May Be Over

By Brian Grow MCI surprises Wall Street with positive earnings report, signaling the worst may be behind it

Yet potential suitors in struggling telecom business remain on the sidelines, waiting for company improve further

That happy "Friends & Family" feeling returned to MCI for a time on Aug. 5, when the beleaguered long-distance outfit surprised Wall Street by turning in less-than-horrible second-quarter earnings, announcing a dividend bonanza, and showing solid progress in cost reduction.

While MCI still managed to hemorrhage $71 million in the quarter, that loss beat analysts' estimates and slowed the bleeding, after earnings sank to $388 million in the first quarter. What's more, MCI's board approved a cash dividend of 40 cents per share to begin in September, part of a $2.2 billion plan to return "excess cash" to shareholders, as MCI exits bankruptcy. The payback went over well investors, who lifted MCI by 17.4%, to $16.25, in after-hours trading Aug. 5. The stock lost a little ground in subsequent trading, closing Aug. 6 at $15.94.

STRATEGIC RETREAT. As arch rival AT&T (T) sounds the siren over asset write-downs and a pullout from the consumer telecom market, MCI's better-than-expected performance could signal that its dog days are on the wane. Indeed, the company, which was wracked by an $11 billion accounting scandal under its former name, Worldcom, produced operating income of $41 million during the quarter.

While analysts don't expect MCI to return to profitability until at least the end of 2005, more stable earnings could sweeten takeover interest in the nation's second-largest long-distance company. Already, buyout firm Leucadia National has dipped its toe in the water, last month filing with federal regulators a request for approval to acquire a majority interest in MCI (see BW Online, 7/13/04, "Telecom Frenzy Round 2? Not Yet").

The long-distance market remains brutal, with prices falling and new technologies threatening MCI's core voice and data business. The end of cheap rates for access to local telephone customers is expected to cut revenues harshly in MCI's consumer and small-business unit. MCI has 3.6 million local customers and 8.8 million consumer long-distance lines. Meanwhile, regulatory changes are increasingly enabling the Baby Bells to hunt for customers in MCI's long-distance segment. The result: MCI said yesterday that it will reduce efforts to attract new consumer customers and revalue some assets, although it doesn't expect to fully exit the segment, as AT&T has done. "We anticipate downsizing our [consumer] acquisition efforts significantly," says Wayne Huyard, president of MCI's U.S. sales and services unit.

"HIGHER-QUALITY REVENUE." Those ailments are forcing MCI to continue slashing costs. During the quarter, MCI cut another 6,200 jobs, trimmed advertising for underperforming businesses such as its 10-10-987 long-distance calling service, and lowered debt levels. The layoffs, part of a plan to reduce MCI's headcount 30% by the end of the year, took its total employee base down to 48,400, from 54,600 at the end of 2003. The cost purge lowered MCI's overhead by 17%, or about $300 million, from the first quarter. Analysts are applauding the results, with JPMorgan's Avi Bennis hailing it as "a really remarkable job."

While substantially lower costs encouraged Wall Street, there were other bright spots for MCI. The company generated $500 million in cash and its EBITDA margin more than doubled to 19%, up from single digits in the first quarter, and just below AT&T's level. MCI executives also crowed that, while rates continue to fall, their outfit won $1.1 billion in new contracts during the quarter from major businesses such as SunTrust Bank (STI) and First Data Corp (FDC). "We're seeing higher-quality revenue," said Capellas, who also announced plans to push wireless voice and data services to corporate clients -- a move made possible by the fact that MCI still holds $4.1 billion in cash.

Indeed, MCI's cash hoard and its stable of big business clients -- Hewlett-Packard (HPQ) and Electronic Data Systems (EDS), to name two -- are appetizing assets for potential suitors. For the moment, most analysts believe potential buyers such as the Baby Bells remain cautious about making a bid until MCI stabilizes. With good reason -- total revenue at MCI is still expected to decline about 14% this year, to about $21 billion, before bottoming out next year at about $20 billion, according to Patrick Guzman, telecom analyst at Variant Research in Miami. Also, competitors aim to pick off MCI's residential customers as it ratchets back efforts to attract new ones.

LOOKING, NOT BUYING. For now, MCI's suitors remain content to sit on the sidelines -- and digest other projects. BellSouth (BLS) and SBC Communications (SBC) are busy closing the $41 billion purchase of AT&T Wireless by their joint-venture cellular unit, Cingular. Indeed, this week, BellSouth CEO Duane F. Ackerman professed to have little appetite for an MCI deal. "We're not in acquisition mode," he said. Another deep-pocketed contender, Verizon (VZ), is busy adding to its industry-leading position in wireless and expanding broadband operation. The upshot: The Bells are reluctant to tinker with their stable margins and steady profitability at a time when MCI is still on the mend, say analysts.

It seems likely, however, that MCI's problems will subside over the next few quarters -- and Capellas and team are managing smartly. Instead of bolting the consumer business a la AT&T for example, MCI plans to milk it "for profitability," while expanding efforts to deliver next-generation, Internet-based services such as data storage, wireless communications, computer security. Given the positive news at MCI, it's easy to understand why investors have decided not to hang up on MCI just yet. Grow is a writer in BusinessWeek's Atlanta bureau

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