Commentary: MCI Is under a New Cloud, but It Can Weather the Storm

By Steve Rosenbush & Charles Haddad

When Michael D. Capellas signed on as chief executive of WorldCom Inc., his track record and business smarts seemed just what the scandal-riddled company needed. And true to form, Capellas moved swiftly to get beyond the company's accounting mess and $80 billion writedown. Yet now, just eight months after taking the job, Capellas is being hit by a new WorldCom scandal that could threaten his plans to lead the company out of Chapter 11 bankruptcy protection by October.

Rivals allege that WorldCom, now renamed MCI, has avoided perhaps as much as hundreds of millions of dollars in fees over a decade by disguising long-distance calls as local calls or as calls originated by long-distance competitor AT&T. The U.S. Attorney's office in New York has launched a probe into the matter even as competitors turn up the heat. SBC Communications Inc. now says it has raised the issue of fees three times with MCI over the past year, sending two letters directly to Capellas in April and June. And on July 28, AT&T threatened to file a lawsuit alleging violations of federal anti-racketeering laws. MCI says it is investigating the allegations. "We have a zero-tolerance policy and if any wrongdoing is discovered you can be certain that we will take appropriate action swiftly," responded Capellas in a written statement on July 28.

How big a problem is this for Capellas and MCI? Well, it isn't pretty, but it isn't the end of the world. While the allegations could slow down the timetable for getting out of bankruptcy, there's little chance that those plans will be derailed. Even if MCI is forced to pay back all of the alleged unpaid access fees plus penalties, it's still highly unlikely the company, with its sprawling long-distance network and $24.5 billion in revenue, would be forced out of business. Says Friedman, Billings, Ramsey & Co. analyst Susan Kalla: "This isn't large enough to push the company into liquidation, not even close."

The controversy stems from telecom's arcane accounting rules. SBC, Verizon, and AT&T say MCI used small carriers to redirect long-distance calls. Their original identifying codes were removed, they say, making it nearly impossible for rivals to charge MCI for completing its calls. MCI maintains that it has already settled previous claims over fees with Verizon Communications Inc. and SBC for $436 million and $107 million, respectively, in July and that it has been negotiating for the past two months to resolve more recent claims.

Now that scandal has erupted, MCI is trying to limit the damage. On July 29, it announced that it hired Washington law firm Gibson, Dunn & Crutcher to lead an internal review. And on the same day Fred Briggs, MCI's president for operations and technology, said MCI will reassess its relationship with least-cost routing companies.

Still, things could get dicey if U.S. Attorney James B. Comey files charges against the long-distance giant. The stigma of criminal charges, which it has avoided so far, could drive away big customers who might be loath to be associated with scandal. The biggest threat: MCI could lose as much as $1 billion in business from its largest customer, the federal government. Even if Comey doesn't press charges, MCI might be compelled to end some of its most aggressive call-routing tactics. If it turns out that those tactics were an essential part of its ability to offer lower prices, big customers might look elsewhere.

Meantime, the longer MCI stays in bankruptcy, the weaker it gets. A delay of six months now looks likely, because creditors may want the new investigation completed before the company emerges from bankruptcy. Otherwise, the company runs the risk of facing liabilities without the protection of the courts. A delay of just six months in implementing the reorg plan could cost tens of millions of dollars in additional legal fees.

So far, Capellas and the company have plenty of support from creditors. "We understand that what MCI did is standard practice," says Mark A. Neporent, co-chair of the MCI creditors committee and chief operating officer of Cerberus Capital Management. "This is nothing but a naked attempt to distract MCI from the goal of emerging from bankruptcy." MCI can only hope the U.S. Attorney's office agrees.

Rosenbush covers the telecom industry from New York and Haddad reports on MCI from Atlanta.

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