Woe Is WorldCom

The vultures are circling. Can Bernie Ebbers ward them off?

It was billed as the strategy meeting not to miss. WorldCom Inc. (WCOM ) senior executives from around the globe gathered two months ago at the telecom giant's headquarters in Clinton, Miss. They had come to hear CEO Bernard J. Ebbers reveal his grand vision for rescuing a company mired in debt, sluggish growth, and rising controversy about its accounting practices. What executives heard instead was their boss thundering about the theft of coffee in the company's break room.

How did Ebbers know? Because he had matched brewing filters with bags, and at the end of the month, filters outnumbered bags. Henceforth, Ebbers commanded, his executives would follow a checklist of priorities now referred to as "Bernie's seven points of light." They would count coffee bags, make sure no lights were left on at the end of the day, and save cooling costs in the summer by turning the thermostat up four degrees, say three former and two current executives. "Bernie is running a $40 billion company as if it were still his own mom-and-pop business," says one WorldCom exec who attended the meeting. "He doesn't know how to grow the company, just shave pennies."

Ebbers needs more than a few pennies to save his fading empire. In the 1990s, the onetime high school basketball coach became an entrepreneurial superstar by building the largest rival to the companies of the old Ma Bell monopoly. He used his soaring stock to make 60 acquisitions, capped in 1998 by WorldCom's hostile takeover of MCI Communications, the country's second-largest long-distance company.

Since then, WorldCom has undergone a stunning reversal of fortune. In 2000, the federal government blocked the company's proposed purchase of Sprint Corp., ending the growth-through-acquisition strategy. Data and Internet services growth has plummeted from 27% in 2000 to an estimated 3% in the first quarter. The core long-distance business is melting down: 13% last year. And in March, the Securities & Exchange Commission launched a broad probe into WorldCom's accounting and its $366 million in loans to Ebbers.

And the worst may lie ahead. On Apr. 19, the company sharply revised its financial projections for 2002, admitting that revenues in its WorldCom Group unit, which serves business customers, would be flat in 2002 at $21 billion to $21.5 billion, down from previous expectations of $22 billion. With the MCI consumer long-distance business shrinking, the company's overall revenues are expected to slip 5% this year, to $33 billion, while net income is expected to drop 40%, to $1.6 billion. The news prompted Merrill Lynch, Credit Suisse First Boston, and A.G. Edwards to downgrade WorldCom to "sell," an almost unheard-of rating. Credit-rating agencies Standard & Poor's and Moody's Investors Service cut the company's debt to two notches above junk status. Its stock plunged 43% in two days, to $3.41 a share.

Some now question WorldCom's survival. It's carrying a teetering $30 billion debt load. While only $172 million in interest and debt maturities come due this year, that will balloon to $1.7 billion in 2003 and $2.6 billion in 2004. Merrill Lynch & Co. estimates that the company, which had negative cash flow of $871 million in 2001, will generate only $564 million in free cash flow in 2002 and $1 billion in 2003. If the company can't generate more cash from its operations or raise money in the capital markets, it could tumble into bankruptcy. "There's a high probability WorldCom will be in Chapter 11. Clearly, we're worried about it," says David Wyss, chief economist for Standard & Poor's. A WorldCom spokesman declined to comment on the possibility of bankruptcy after the earnings warning.

The cash crunch could become critical as early as next year. WorldCom has $1.4 billion in cash and $8 billion available through its bank line now. But $3.8 billion of the bank line will expire this June, and WorldCom has said it won't try to extend it. In 2003, an additional $2.7 billion in bank credit could expire, leaving just $1.5 billion in available credit. That year, WorldCom will have to repay $1.7 billion in maturing debt. "I can hear the clock ticking on WorldCom," says telecom analyst Susan Kalla of Friedman, Billings, Ramsey & Co. "I think the company is facing a doomsday scenario."

The vultures are circling. Verizon, SBC, and BellSouth all have talked to WorldCom about acquiring the company in recent months, according to WorldCom executives and investment bankers. The talks have stalled, largely because the terms offered have been unacceptable to Ebbers. Last fall, Verizon Communications offered no premium over WorldCom's stock price, then about $13, and offered only to make Ebbers a powerless vice-chairman. SBC insisted that Ebbers resign as part of a deal. And BellSouth Corp., which was approached by WorldCom about a merger, wanted nothing to do with the company's $30 billion in liabilities.

As recently as February, Ebbers staunchly denied the possibility of bankruptcy. He has said WorldCom will generate $700 million in cash this year, $1.7 billion in 2003, and $3 billion annually beginning in 2004. That would be more than enough to cover the $4.5 billion in debt maturing in the next three years. "Bankruptcy or credit default is not a concern. To question WorldCom's viability is utter nonsense," Ebbers said on a Feb. 7 conference call. Ebbers and other senior execs declined repeated requests for comment in April. This story was put together based on interviews with 36 current and former employees, investors, analysts, and rivals.

Despite the brutal industry downturn, Ebbers has said WorldCom will recover as the economy picks up over the next year. Addressing investors at a Merrill Lynch conference on Mar. 12, he laid out the company's strengths: a $10 billion global network with the broadest range of data services in the world, and a host of big customers like Federal Express, AOL Time Warner, and Nasdaq. He also explained steps the company is taking to boost growth. It's reorganizing the sales force to make it more productive. It's creating a sales team that will focus on the European market, which is growing 20% a year. And it's targeting U.S. corporate customers that spend more than $1 million a year with WorldCom but still buy most of their telecom services elsewhere. "We are well-positioned for when the economy begins to recover, with a great base of enterprise customers whose needs will grow," he said during the Merrill Lynch conference.

But some institutional investors say Ebbers may not be around when the economy fully recovers. Four money managers told BusinessWeek they would like to see Ebbers step down. Investors, however, say they have not pressured the board or done anything else to apply pressure publicly because they are afraid it would push the stock price even lower. Board members did not return calls seeking comment.

Still, the heat on Ebbers is rising. The SEC inquiry was prompted in part by WorldCom's decision to loan Ebbers $366 million to pay off margin debt so that he wouldn't have to sell his 17 million shares of WorldCom stock. Ebbers has said he will sell personal investments to repay the money, although it's unclear how quickly he can unload his assets. The commission is looking into the terms of that loan, as well as 23 other matters, including the commissions paid to 14 fired sales reps and possible revenue inflation. "There will be no under-the-table deal to settle this inquiry," says one Big Five partner who has worked on WorldCom. "Every dollar of revenue that agency finds WorldCom never really received will have to be restated."

Most dangerous may be the SEC's questions about WorldCom's acquisition accounting. The company has said that it plans to write off as much as $20 billion of its $50 billion in goodwill because of declines in the value of companies it purchased. But some experts, including Baruch College accounting professor Douglas Carmichael, say the charge could be much higher because telecom companies have been hammered recently. If the SEC forces the company to take a charge exceeding $45 billion, WorldCom could lose access to the $8 billion bank credit line it's counting on as a cushion to carry it through the tight times ahead. A WorldCom spokesman says that's highly unlikely.

As Ebbers faces the biggest challenge of his career, his response has been to fall back on his tried-and-true approach of cutting costs. His career was set in motion in the mid-1960s when he quit his job as a bouncer at a bar in his native Edmonton, Alta., and moved south to play basketball at Mississippi College. After graduating in 1967, he coached basketball and invested in several businesses, including a motel and a long-distance company called Long Distance Discount Service. When LDDS ran into financial trouble, Ebbers took over the CEO post, cutting costs to return the company to health.

Now Ebbers is sharpening his pencil once again, to save WorldCom. The biggest target is the company's capital budget, which peaked in 2000 at $11 billion. Ebbers has announced plans to cut capital spending this year to $4.5 billion, down from $8 billion in 2001. That's still 21% of revenues, slightly more than the industry norm of 20%. But WorldCom could lose its competitive advantage in data and Net services if it cuts back further in the years ahead. "Over time, this would erode WorldCom's competitive position, especially as [the Bells] secure long-distance approval and begin targeting enterprise customers," says analyst Adam Quinton of Merrill Lynch.

Ebbers' other cost-cutting measures, at times, border on the absurd. Another of his "seven points of light" was the decision to stop watering WorldCom's plants and let them die to save money, according to two former execs. A few months ago, he installed a video camera above the outdoor smoking area to record the length of employees' breaks, four current employees say. And for the first time, Ebbers insists on approving every expenditure over $5,000, as well as signing off on all press releases, say two current employees. A WorldCom spokesman declined comment on the cost-reduction measures.

WorldCom insists that this cost-cutting will allow the company to survive. Even after the Apr. 19 warning, WorldCom expects to generate positive free cash flow in 2002 for the first time since 1998. And some analysts agree: Lehman Brothers Inc.'s Blake Bath expects the company to generate enough free cash to avoid any liquidity troubles. "The bull story is that AT&T and WorldCom are the only main alternatives for providing service to large corporations," says Robert N. Gensler, manager of the $4 billion T. Rowe Price Media & Telecommunications Fund, which owns 11.8 million shares.

The bears are on the prowl, though. Some money managers, including Invesco Telecommunications Fund, have bailed out of WorldCom's stock as it plunged 94% from its $60.50 peak in July, 1999. The company's bonds are trading as if they were junk bonds. The price dropped from 85 cents on the dollar in March to 67 cents on Apr. 22, after the company's latest profit warning.

The SEC inquiry could give investors more reasons for concern. Ebbers long burnished WorldCom's results through aggressive bookkeeping, according to two accountants who have done work for WorldCom, four current employees, and three former division heads. He would, for example, capitalize costs that other companies booked as regular expenses. In 2000, according to a footnote in the company's annual report, WorldCom capitalized $925 million in costs associated with developing in-house software. And Ebbers took huge write-offs associated with acquisitions, enabling him to pump up future earnings. For example, the SEC is looking into a $685 million write-off the company took in the third quarter of 2000 for the acquisitions of MFS Communications and MCI. WorldCom denies any wrongdoing. "I remember Ebbers telling me once, `We won't have to worry about earnings-per-share growth for years, with all our acquisitions,"' says a former division head. "He was right--and we all thought he was a genius at the time."

The SEC also is probing WorldCom's "take or pay" contracts. Under such a contract, customers get a discount if they agree to use a certain volume of service over a specific period of time. If they use less service, then they have to pay a penalty. Right now, many customers aren't using the network as much as they agreed to, yet they're refusing to pay the penalty. WorldCom isn't enforcing the contracts, fearing customers will jump to other providers, given the glut of network capacity. Nonetheless, the company may still be booking the full value of the contract, inflating its revenue figures, say three accounting consultants who have done work for WorldCom. WorldCom declined comment.

Investors and analysts are increasingly concluding that there's no way out for WorldCom. The company bet the ranch on the long-distance voice and data business in the '90s. Now the value in telecom is going to wireless and local phone service. "We continue to be concerned about WorldCom being a virtual pure play in long distance, not a sustainable position in the long run, given commoditization and competitive trends," says CS First Boston's Reingold. And one possible exit, an eventual buyout by one of the Bells at a fire-sale price, probably won't do investors any good.

Corrections and Clarifications In "Woe is WorldCom" (Information Technology, May 6), a statement from Standard & Poor's Chief Economist David Wyss requires clarification. He meant to say that WorldCom's stock and bond prices indicate that investors are worried the company may go into bankruptcy. He did not mean the statement as Standard & Poor's opinion.

By Charles Haddad in Atlanta, with Steve Rosenbush in New York

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