For Mike Capellas' Next Trick...
Michael Capellas has been one busy rescue worker. It was only in November that he quit his No. 2 job at Hewlett-Packard (HPQ ) Co. to resuscitate the bankrupt telecom giant WorldCom Inc. Since then, he has slashed costs, crisscrossed the country to boost employee morale, and moved headquarters from Clinton, Miss., to the Washington suburb of Ashburn, Va. And in April, Capellas announced a deal with bondholders to slash the company's debt from $41 billion to $5 billion.
This work should pave the way for the company to emerge from Chapter 11 around September (on May 19, the Securities & Exchange Commission proposed a $500 million fine for the past accounting transgressions). And to help wipe away the bitter taste from the biggest case of corporate fraud in history, Capellas has renamed the company after the largest and most famous of the 70 acquisitions in its history, MCI.
So will the reborn MCI be the lean, debt-light fighting machine that the rest of the telecom industry has been dreading? Not yet. While Capellas is likely to meet near-term financial goals, he's grappling with a host of challenges, from fouled-up billing systems to overlapping data networks. Most grave, since entering bankruptcy last July, MCI has lost three percentage points of the market for small and medium-size business customers, representing revenue of $2 billion to $3 billion. And according to a Merrill Lynch (MER ) & Co. survey of chief information officers, nearly 30% of MCI's current customers may not renew their contracts. Harvey Borden, CIO at G&G Retail, a chain of girl's clothing stores, switched to MCI's rival, AT&T (T ) early this year. "Our network has to work flawlessly," he says. "I just couldn't take the chance."
Capellas' goal is to turn MCI into the smooth-running powerhouse that founder Bernard J. Ebbers envisioned but never delivered. To do that, the new CEO must stretch far beyond his proven expertise as a turnaround artist and establish himself as a telecom whiz -- mastering the nitty-gritty of operations. This means shoring up MCI's hollowed-out sales force, mending relations with customers, and integrating the company's disparate data systems. Capellas declined comment for this story.
He's playing catch-up in a down market. MCI's profit margin is only 15%, compared with 26% for supposedly stodgy old AT&T. Revenue growth hinges on winning battles with a host of hungry rivals, including AT&T, Sprint (FON ), and newcomers to the long-distance business such as Verizon Communications (VZ ). What's worse, the consumer long-distance business is declining about 10% this year.
There are some signs of hope, though. Capellas, according to his reorganization plan filed in April, intends to have the $24.6 billion company growing at a 4.5% clip by next year. To offset declines in the consumer unit, business services must grow 10% a year. For most rivals, this sector is in decline. Yet one person close to MCI says its business services revenue bottomed out last fall and is now stable.
The Chapter 11 restructuring will help, but not as much as many think. The company has reduced the interest on its debt to about $300 million a year, down from $1.5 billion before the filing, says analyst Susan Kalla of Friedman, Billings Ramsey & Co. AT&T, by comparison, is paying more than $1 billion to service its $13.7 billion in long-term debt. Yet AT&T, with about $9 billion in cash flow -- more than double MCI's level -- can handle higher debt.
One thing working in Capellas' favor is MCI's network. Over the past six years, the company invested $38 billion in overhauls. That project helped bankrupt the carrier. But most of that debt will be eliminated in bankruptcy court, where creditors are expected to swap all but $5 billion in debt for equity. And the state-of-the-art global data network, which is hooked into markets such as Paris and Frankfurt, now supports everything from Internet phone calls to Internet videoconferencing, which are likely to become important services in the next few years. "Our network is the envy of the business," says Jonathan Crane, MCI's executive vice-president for strategy and marketing.
If Capellas, whose turnaround at Compaq ended in a merger with HP, can transform this network into a cash machine, he'll revive MCI -- and make good money, too. Capellas gets a $1.5 million salary and a $1.5 million bonus. He could also receive $12 million in restricted stock over three years, when the stock is trading again after MCI emerges from bankruptcy. He could land an additional $6 million in restricted stock for "exemplary performance," yet to be determined by the courts.
MCI insists its growth targets are easily within reach. Even now, it says its backlog of orders in the sales pipeline is rising and will produce higher revenue in six months. It still has a massive presence in the business market, and when business spending on telecommunications picks up, MCI should be one of the main beneficiaries. "With a monthly revenue run rate today of more than $2 billion, and an assumption that our business will experience at least a small bounce coming out of Chapter 11, we're very comfortable with our 2004 revenue target," Crane says. Alex Peters, co-manager of the Franklin Global Communications Fund (FRUTX ) believes a combination of lower operating costs and higher revenue will help MCI meet its targets. "It won't be easy," he says. "But I think MCI can do it."
Capellas is laying the foundation for even more revenue growth. He's hiring more than 1,000 salespeople to boost the sagging small and medium-size business sales unit, which is smaller than AT&T's. At the same time, though, he's raising fears within the industry of a price war. To hold on to one midsize corporate customer in the Northeast, MCI slashed the price of the three-year contract from $1.25 million to $900,000, say consultants familiar with the deal. MCI executives say they have no intention of starting a price war, but some experts are concerned. "It's not good, that's for sure," says Richard J. Klugman, a telecom analyst at Jefferies & Co.
Capellas is looking to cut costs by revamping internal tech systems, which are a mishmash left from Ebbers' acquisition frenzy. MCI has a staggering 170 service and sales systems. Capellas has hired Siebel Systems (SEBL ) Inc. to tie together all these systems on a common platform. The company has done similar work for other telecom carriers such as BellSouth (BLS ) Corp. and SBC Communications (SBC ). Still, the MCI project is more complex and will take years to complete. Capellas also is looking to hand over the management of MCI's vast internal networks to an outside supplier. He has solicited bids from IBM and others. The company won't say how much the cost cuts will save.
The next year is crucial for Capellas' turnaround. Success will require near-perfect execution in the face of brutal competition. But if Capellas can deliver, and if the economy doesn't fall back into recession, the new MCI could last a lot longer than WorldCom.
By Charles Haddad in Atlanta