MCI's Expert Repairman Has A Tough Assignment

Capellas has the credentials to save the former WorldCom, but this game may be unwinnable

Hours after taking over as chief executive of WorldCom Group (WCOEQ ) on Nov. 15, 2002, Michael D. Capellas came face to face with the reality of running a scandal-ridden and bankrupt company. Capellas flew down to the sprawling campus in suburban Virginia, rounded up senior management -- a paltry six executives who hadn't been indicted, fired, or driven out -- and put them on stage before 4,000 employees. "Who are these guys?" someone shouted from the audience. Capellas realized that the question was no joke. "It was a defining moment for me," he recalls. "People didn't even know their own senior management."

No one can say that today. Since he came to WorldCom -- which now is in the process of renaming itself MCI -- Capellas has seemed to breathe life back into the company by sheer force of will. He rallied its 55,000 employees demoralized by an $11 billion accounting scandal, coaxed warring creditors to accept a bankruptcy reorganization plan, and schmoozed big customers until they felt guilty about jumping ship. He persuaded the General Services Administration to lift a ban against MCI bidding on federal contracts. And today he has some investors believing again: On Jan. 16, Mexican billionaire Carlos Slim Helú said he would consider converting his bond holdings into as much as 12% of MCI stock once it emerges from bankruptcy, sometime this winter. Company insiders say Slim is betting MCI will prosper on its own.

But will MCI wind up standing on its own? For all the energy and emotion that Capellas generates, it looks like he has again joined a game that was unwinnable from the start. As when he became CEO of troubled Compaq Computer Corp. -- which he wound up selling to Hewlett-Packard Co. (HPQ ) in 2002 -- Capellas is trying to implement an ambitious strategy at a company that has slipped way behind in fundamental matters of finance, operations, and reputation.

HOBBLED GIANT. At best, critics expect Capellas' outfit to muddle along with high-single-digit margins, but in the end to be sold to one of the local Bell operating companies. "In many ways, Capellas has done a fantastic job. But he's just not going to be able to catch up," says Richard G. Klugman, a telecom analyst at Jefferies & Co. "The world has moved away from MCI."

Capellas says he knows what MCI needs to become: the network of choice for consumers and companies alike, connecting to everything from cell phones to computers to MP3 players. Today, MCI's network can't connect wirelessly with MP3 players, and it doesn't offer cell-phone service. Capellas is working to offer both. The problem is, MCI's rivals are also building seamless networks. And MCI remains a hobbled giant. True, the global reach of its data network remains second to none, and Capellas used bankruptcy court to slash debt and raise a mountain of cash. But MCI's debt-to-capital ratio is estimated to be 19% this year, compared with 13% at AT&T (T ), according to Susan Kalla at Friedman, Billings, Ramsey and Co., Inc. And free cash flow and earnings before interest, taxes, depreciation, and amortization (EBITDA) still lag AT&T and Sprint Corp. (FON ). So does capital spending.

At the same time, MCI is still struggling with the troubled legacy of founder and former CEO Bernard J. Ebbers. He bought company after company but never integrated their operations. Today, MCI remains a jumbled conglomeration of 222 legal entities, many with conflicting collection and accounting systems. Capellas must upgrade and meld these systems while trying to introduce new services. It's a tall order that few believe he can meet. Plus, the scandal could still prove costly -- on Jan. 26, an examiner in the bankruptcy case suggested states might pursue MCI or accountant KPMG for back taxes avoided through "highly aggressive" strategies. MCI disputes the findings and says its tax plan was legit.

What gives his backers hope is that Capellas so enthusiastically embraces hopeless situations. A pudgy, bookish boy who liked to write poetry, Capellas decided in eighth grade he wanted to play football. Never mind that a congenital disease nearly blinded him in his left eye. He whipped himself into linebacker material with a homemade weight-training machine: a thick rubber band lashed around a telephone pole. "If Mike decides to do something, you'd better get out of his way," says his brother, George. It's a trait he inherited from his father, a Greek immigrant who worked his way up from laborer to superintendent at the Republic Steel Corp. plant in gritty Warren, Ohio.

As an undergraduate at Kent State University, Capellas fell in love with computers. He still fondly recalls feeding hundreds of punch cards into a refrigerator-size machine to solve simple math problems. But his future wife, Marie Angelillo, knew Capellas was destined to be more than just a computer programmer. "Michael always said he wanted to sit at the strategy table with the top executives," she says. She married Capellas in 1979, and for the next 20 years they crisscrossed the globe as Capellas climbed the ranks at Schlumberger (SLB ), Oracle (ORCL ), and SAP (SAP ).

MASTER MOTIVATOR. Capellas' big break came when Compaq unexpectedly promoted him from chief information officer to CEO in 1999. Archrival Dell Inc. (DELL ) had jumped ahead by figuring out how to sell PCs cheaply online, and Compaq was in so much trouble that its board couldn't attract a high-profile savior. Even Capellas hesitated. He finally took the job and put in place a strategy that boosted sales, but it wasn't enough to catch Dell. In the end, the sale of Compaq left many wondering if this master motivator could reshape a company around his vision. "He gutted out the crisis, no question about that," says a former Compaq director who asked not to be identified. "But he couldn't come up with a winning plan to put the company back in the fast lane."

At MCI, Capellas has done more than win over WorldCom survivors. He recruited first-class talent to fill the thinned-out senior management, luring heavyweights such as former AT&T exec Richard R. Roscitt as president and financial whiz Robert T. Blakely, who managed the restructuring of chemical giant Tenneco Inc., as chief financial officer. Capellas persuaded Deloitte Touche Tohmatsu to assign 600-plus accountants to clean up MCI's fraudulent accounting. And he held on to wavering customers. In one day last summer, he visited three clients in Los Angeles, led an employee pep rally (shouting, "All those of you who don't want to get out of bankruptcy, raise your hand!"), and then escorted 10 clients to a Rolling Stones concert. "With customers, Mike reminds me of Jay Leno, the way he'll walk among them, pressing the flesh and telling jokes," says Michael D. Fleisher, Gartner Group's (IT ) CEO.

Capellas has a plan for a next-generation phone giant: It's all about offering an attractive package of services priced lower than if they were sold separately. This bundle has to include high-speed Internet access and local and long-distance phone service. That's why Capellas won't sell off these low-margin businesses. But he also needs a cell-phone option; MCI is the only major carrier that can't offer wireless service. Capellas is working to partner with a wireless operator. The company has had preliminary talks with Nextel Communications Inc. (NXTL ). But no deal is imminent, say insiders.

Clearly, the futuristic aspects of that plan are what most captivate Capellas. He has put together a new team of some 500 developers trying to devise new software-driven services. At any one time he carries a cell phone, pager, PDA, and MP3 player. "Oh boy, you should hear him when all of this stuff goes off at once," says his executive assistant, Grace Trent, covering her ears with her hands. After work, he spends the wee hours of the morning teaching himself XML, the programming language used to create many new digital services, such as retrieving voice mail off the Internet and e-mail off voice systems.

And Capellas can't stop talking about Internet telephony, which moves digitized voice calls through the Net. It's a business he believes MCI can and must dominate. Considering the global reach of the company's networks, "MCI wins if IP [Internet protocol] telephone takes off," he says. But such phone service is a long way from widespread acceptance. The technology is still unreliable and insecure, which is why none of MCI's big corporate customers has signed up.

SELL OR DIE? That's bad news, because MCI needs to offer something novel to hold on to old customers and attract new ones. While no large companies have dropped MCI, they have transferred more of their business to competitors to win lower prices and hedge against more bankruptcies. MCI's share of North American revenue has steadily dropped, from 32% in 2001 to 28% last year, according to San Francisco telecom consultant Ryan Hankin Kent Inc., and its EBITDA margins are only 11%, less than half the 26% margins at Sprint and AT&T.

For all of Capellas' ideas, MCI's weak position may doom its chances of staying in business. The best option is probably a sale, and the most likely buyers are the local telephone companies, which have the financial wherewithal to shore up MCI's capital spending and make it competitive again. MCI's corporate customers would open a market for the local carriers that they haven't been able to crack on their own. "The war is over, and the Baby Bells have won," says Ken McGee, an analyst at Gartner Group. "We're seeing the end of the likes of MCI and AT&T. Capellas can't change that."

For a CEO who played a significant role in the final days of the PC Clone Wars, such talk has to sound all too familiar. Capellas doesn't rule out a sale if he gets the right offer. For now, he's operating as if MCI can and should stand alone. Still, once again, Capellas may have arrived just in time to stamp out the fires at a once-trendsetting company, but too late to make much of a difference in the long term.

By Charles Haddad in Ashburn, Va.

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