The Axman Cometh?
It was the biggest deal Bernard J. Ebbers had ever done. Back in 1992, LDDS Communications Inc.--as WorldCom Inc. was then known--acquired the slightly larger Advanced Telecommunications Corp. to create a $700 million company. Ebbers wasn't daunted by the prospect of buying a bigger company. After all, he had a formula that had already paid off in a series of smaller deals: Choose your target, snap it up, take big cost cuts to preserve operating earnings and keep your stock price up--and get ready for the next deal.
It sure worked. Ebbers slashed sales, general, and administrative (SG&A) expenses to 17% of sales from 24%, eliminating costly executive perks and anything else that might drag down profit margins. "Bernie's not a big believer in entertaining big customers or spending a lot on advertising," says Norman Klugman, Advanced Telecom's former chief operating officer and COO for six months after the merger with LDDS. "Practically every area got cut."
Can the Ebbers formula work if he succeeds in his $30 billion bid for MCI Communications Inc.? He has little choice but to try--he can't afford to let MCI's higher costs drag down his earnings and devalue his stock. WorldCom shares, which have risen 50% annually for the past 10 years, are the powerful currency that fuels the current dealmaking boom--in telecom and elsewhere (see page 132). "It's a great stock to own. It's not a great place to work," says one former WorldCom employee, who recalls that a few years ago, Ebbers was so focused on costs that he reviewed expenditures even for personal stationery.
But cutting too deeply at MCI could backfire. Unlike the other companies that make up WorldCom, which serve mainly business customers, MCI has a big consumer business, which requires costly marketing and advertising. Business customers have swarmed to WorldCom because it passes on its cost cuts in prices that are lower than its competitors. Cincom Systems Inc., a Cincinnati-based software company, switched its U.S. long-distance business to WorldCom from MCI earlier this year "because they came in 20% lower," says William Dyer, director of information systems and technology services. Consumers, on the other hand, need to be wooed and re-wooed as long-distance companies one-up each other with new service offers and discount plans.
"RUDE AWAKENING." Certainly MCI offers a juicy target for a cost-cutter. In 1996, the company's SG&A costs totaled $5 billion, or 27% of its $18.5 billion in sales. That's in line with overhead at Sprint and AT&T. But Ebbers has been requiring SG&A of roughly 18% of sales in recent years. "He always has in his mind certain targets," says Howard Finkelstein, former president of Metromedia Communications, which merged with Ebbers' company in 1993.
To reach Ebbers' usual target levels, MCI would need to cut costs by at least $1.5 billion. "For a proud company like MCI, I suspect it's going to be a rude awakening," says one person familiar with Ebbers' management. Likely areas for cuts are advertising, communications, legal, and other headquarters functions. Ebbers says he does not plan major layoffs. Instead, he says, he wants to increase sales to offset overhead costs.
How far will Ebbers go at MCI? Funding the advertising needed to attract consumers is difficult--if not impossible--within his usual cost parameters. "You can't run a consumer long-distance business with 18% SG&A," says an exec close to Ebbers. Indeed, shortly after the MCI bid was announced, John W. Sidgmore, WorldCom's chief operating officer, suggested in an interview with The Washington Post that WorldCom may exit the consumer long-distance business. But the company later said it has no plans to abandon consumers.
WorldCom may be ready to modify its model a bit. Even without MCI, analysts say the company needs to put more into network reliability. They say customers complain of poor service, particularly in some high-speed data networks. Gartner Group Inc., a market-research firm, is advising clients to delay signing contracts with MCI until they learn whether WorldCom would invest in the support they would want.
Ebbers may also have to pay to keep MCI executives. Often, executives at companies Ebbers acquires never join WorldCom--or leave fast. For example, the CEOs of WilTel and MFS Communications Co. are no longer at WorldCom, and the CEO of Metromedia Communications never joined. "He's going to have to try to retain more of the MCI execs," says Gregory LeVert, a former top executive at both WorldCom and MCI.
The WorldCom CEO has already broken his own rules once. Last year, as part of WorldCom's acquisition of MFS Communications, Ebbers also got UUNET Technologies Inc., the No. 1 Internet service provider. At first Ebbers did not want UUNET--but he later realized its potential and restrained from major cuts. But UUNET is the exception.
Ebbers has set high expectations for a combination with MCI. He predicts that the two companies could save $2.5 billion in operating and capital spending costs in 1999, rising to $5 billion in 2002. Most of that will come from reduced operating and capital spending costs. That would be good--because this time, Ebbers may have to give his budget ax a rest.