Bankruptcy Might Whip WorldCom into Shape

The announcement had been expected for weeks. On July 21, WorldCom Inc., the nation's No. 2 long-distance carrier and top carrier of Internet traffic, declared bankruptcy in New York. The company's decision to seek protection from its creditors amounts to the biggest Chapter 11 filing in U.S. history and marks an ignominious fall from grace for one of the tech boom's highest-flying players.

But the WorldCom story is far from over. Assuming its customers don't abandon it--and CEO John Sidgmore is working overtime to prevent that--the company looks likely to emerge from bankruptcy stronger than ever. The very idea is giving WorldCom's rivals palpitations. With most of its debt erased--and most of its assets intact--a post-bankruptcy WorldCom would be in a position to slash its prices and grab share, inflicting more pain on a sector already suffering from a vicious price war and overcapacity. "This is anything but positive for the industry," says Credit Suisse First Boston analyst Daniel P. Reingold.

Like many of WorldCom's rivals, he believes the industry would be better served by consolidation. Long-distance carriers and Baby Bells alike have eyed WorldCom's assets, and most would like to see the company split up and sold off.

But it's not up to the industry. What happens next will depend largely on WorldCom management and its bondholders, both of whom are expected to fight tooth and nail to keep the company together. While its lenders had the upper hand before WorldCom filed for bankruptcy, now the power has shifted to the bondholders, say people close to the action. That's because they hold most of WorldCom's outstanding debt--$29 billion to the banks' $2.65 billion. Moreover, the bank loans were unsecured, which puts lenders in the same category as suppliers--near the back of the queue. "Lenders will get a few seats for appearances' sake, but the bondholders will call the shots," says an attorney representing one of them.

That's how it looks now, although things could change as the bankruptcy goes forward. As it stands, WorldCom officially has 120 days to negotiate a reorganization plan with bondholders, banks, and other creditors. But the process is expected to take a minimum of nine months because dozens of different parties--bondholders, lenders, and vendors--are angling to retrieve a total of $41 billion. The bondholders favor a debt-equity swap, since gaining a stake in a healthy, ongoing business with a clean balance sheet is their only hope of getting any of their money back. They will dominate the creditors committee, although the lenders and vendors must be appeased, and they won't go quietly.

Moreover, the process could be derailed by the discovery of more accounting irregularities, which might prompt creditors to demand that the judge replace company negotiators with an independent trustee. Already, creditors are pushing hard to oust Sidgmore, though for the moment his job is safe, thanks to strong support from the board of directors. "It's not that we think Sidgmore has done anything wrong," says a creditor. "We just want a fresh start, someone not associated with the current mess."

So what is likely to be hived off to raise cash? The various parties are likely to agree to sell off such unprofitable assets as its wireless resale and SkyTel Corp. paging businesses. However, the company and its bondholders are expected to fight mightily to hang on to three core assets: worldwide data network UUNET, WorldCom's corporate-long-distance business, and consumer-long-distance company MCI Group. While MCI's revenue is expected to fall an additional 15% to $8.3 billion this year, the company still accounts for 24% of WorldCom's revenue. WorldCom wants to keep MCI because it's a cash cow and any likely buyer would yank its long-distance traffic from WorldCom's network.

For its part, UUNET represents 30% of the U.S. Internet traffic. The likes of AOL Time Warner (AOL ), Nasdaq, and FedEx Corp. (FDX ) use UUNET for everything from virtual private networks to Web hosting to Internet access. While growth has slowed sharply since the boom years of the late '90s, data and Internet services are expected to be up 5% to 10% overall next year, with international business surging the most, up 14%, according to Reingold. That's made UUNET, with sales of $4.7 billion, the most promising part of the company. Executives and the bondholders believe a revitalized WorldCom could be built around MCI and UUNET.

Key to their strategy, of course, is convincing WorldCom customers to stay the course. Big corporations don't like switching data or long-distance carriers because of the potential disruption to their operations. Still, some are clearly spooked. Apple Computer (AAPL ), CNET Networks (CNET ), and Logitech (LOGI ) have all shifted some of their business from WorldCom to Sprint (FON ) and AT&T (T ). Says Sprint Corp. CEO William T. Esrey: "We're picking up substantial business--literally daily." And WorldCom recently lost out on a multibillion-dollar contract to revamp the federal flight control system. "It feels like we're getting kicked in the gut," says Jerry A. Edgerton, WorldCom's longtime vice-president of government markets. "Every day it gets harder to win a new government contract." If the departures become an exodus that could mean big trouble. Friedman, Billing, Ramsey Inc. analyst Susan Kalla calculates that WorldCom could withstand no more than an 8% drop in revenue from departing customers. Much more, and "they'd be toast for sure," she says.

That explains why Sidgmore and other top execs are each making reassuring calls to up to 20 corporate customers a day. Company salesmen also remain on the offensive. They're offering customers as much as $30,000 as a signing bonus to stay on, according to Sprint and AT&T. And they're matching whatever terms those two rivals are offering. The blitzkrieg seems to be working so far. Sprint and AT&T execs say they haven't yet managed to shake loose any of WorldCom's prize customers.

If WorldCom retains its customer base and manages to emerge from bankruptcy intact, its prospects are excellent, say analysts. Not only would it be virtually debt-free, but by then the company would have shed tens of thousands of jobs, thanks to pre-bankruptcy cuts and the sale or dismantling of some unprofitable units. Moreover, as part of the restructuring, WorldCom says it will shut down underutilized networks, saving millions in operating expenses. And because the company won't be adding capacity, it will be able to cut capital expenditures from $2.5 billion today, to some $500 million. The result: one mean, lean competitor. First, though, WorldCom must get through the bankruptcy in one piece.

By Charles Haddad in Atlanta, with Roger O. Crockett in Chicago and Heather Timmons in New York

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