The SEC Goes Goodwill Hunting at WorldCom

On Mar. 11, WorldCom joined Global Crossing and Qwest Communications (Q ) on the list of telecom companies with accounting practices that are under review by the Securities & Exchange Commission. The telecom giant says it's cooperating fully. WorldCom Inc. Chief Financial Officer Scott D. Sullivan said the company has been reviewed repeatedly in recent years and satisfactorily answered all questions.

Still, the inquiry poses a real danger. The SEC requested documents on a sweeping range of topics, including disputed customer bills, sales commissions, and WorldCom's (WCOM ) loans to its officers and directors. The latter would presumably include the $340 million that CEO Bernard J. Ebbers owes the company.

Perhaps most serious of all, the SEC wants information about how WorldCom accounted for the goodwill it built up while acquiring 60 companies, including long-distance player MCI Communications. Goodwill is an accounting term that describes the amount by which a purchase price exceeds the value of the acquired company's tangible assets. WorldCom's goodwill swelled to $50.8 billion at the end of September. Under new accounting rules, a company needs to write down its goodwill if the value of the acquired company suffers a sustained decline. Already, WorldCom has said it will take an estimated $15 billion to $20 billion charge to write down its goodwill. However, the SEC inquiry could force WorldCom to take a bigger writeoff, says credit analyst David Peterson of Fitch Inc. in Chicago.

That could create a cash crunch. The telecom company now has an $8 billion bank credit line that it can draw on if it needs additional cash. Those untapped loans require that WorldCom keep its debt-to-capital ratio at 68% or less. Today, WorldCom's ratio is 34%. A $20 billion writedown would up that to 44%, according to Merrill Lynch & Co. WorldCom would pass the 68% threshold if its writeoff exceeds about $45 billion. "The SEC inquiry certainly raises the possibility that a larger writedown in goodwill may be needed," says Douglas R. Carmichael, an accounting professor at Baruch College, who says it's possible that WorldCom may have to write off all of its goodwill since the telecom industry is so troubled. WorldCom dismissed the scenario. "The prospect of a larger writedown is hypothetical and we certainly don't expect it to play out," says company spokesman Brad Burns.

Without access to its bank credit, WorldCom might have trouble making payments on its debt. Those payments total $172 million this year. But WorldCom is supposed to repay $1.7 billion in 2003 and $2.6 billion in 2004. Ebbers says WorldCom won't fail. "WorldCom is a viable entity going forward," he says.

Yet supporters are abandoning ship. Merrill Lynch analyst Adam Quinton downgraded WorldCom from a "buy" to a "neutral" just before Ebbers took the stage at the Merrill Lynch conference Quinton was hosting. Quinton said it was inappropriate to have a positive rating given the uncertainty of the SEC inquiry. Those doubts won't be dispelled any time soon.

By Steve Rosenbush in New York

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