MCI's Capellas: "We're Not A Phone Company"

CEO Capellas is pushing MCI into tech services. Can he keep buyers at bay?

These have been dog days at MCI Inc. (MCIP ) Beaten down by an $11 billion accounting scandal, bankruptcy, and a brutal price war, the long-distance giant is expected to lose $3.8 billion in 2004. Its disgraced former chief executive, Bernard J. Ebbers, just went on trial for accounting misdeeds. And after 18,000 job cuts in three years, the cavernous halls of its Ashburn (Va.) headquarters echo.

Visit the corner office of CEO Michael D. Capellas, though, and little seems amiss. He bounds about shooting video from his mobile phone and delivering pep talks about the wave of companies adopting Internet technology for everyday communications. Asked how an old-line telecom company can hope to surf that wave, he says: "It's called $6 billion in cash and zero net debt."

Now BusinessWeek has learned that the beleaguered long-distance company is poised to put its piggy bank to work. The goal: to overhaul MCI from a shrinking carrier of commoditized voice traffic into a New Age network that delivers high-margin Web services such as computer security. To do it, MCI plans to convert thousands of miles of cable in its traditional phone network over the next two years to Internet technology capable of zapping the billions of bytes necessary to deliver such services.

More important, MCI is planning on making a series of at least three acquisitions in the first half of this year to beef up the tech services it can offer corporate customers, according to two insiders. It's a makeover that Capellas believes will allow MCI to survive as an independent company. "We've got the time, we've got the network, and we've got the customers," he says. "We're not a phone company anymore. We're going to define ourselves on our own terms."


Capellas is kicking off the transformation by plunging into the security business. On Jan. 20, MCI expects to complete the acquisition of Network Security Technologies Inc., whose customers include Reuters Group (RTRSY ), Time Warner (TWX ), and the U.S. Treasury. The company's software is designed to allow MCI to stop viruses and worms before they ever reach its customers' desktops. The idea is that large corporate and government customers will pay MCI monthly fees of $100,000 or more to protect them, rather than spending millions to erect their own defenses.

Next up are acquisitions that will let MCI expand its software hosting, which allows companies to use a program for processing e-mail or other functions without the hassle of installing and managing it themselves, and content delivery, so companies can stream audio and video into offices and conference rooms. "MCI recognizes a fundamental truth: It is impossible to survive on basic [telephone] revenue. They have to climb the food chain," says Thomas L. Nolle, president of CIMI Corp., a New Jersey telecom consulting firm.

Or get gobbled by a rival. MCI is one of the most frequently mentioned takeover targets in the industry and Capellas, despite his ambitious strategy, will have trouble keeping the company out of the jaws of its rivals. MCI's market cap is a meager $6.2 billion, barely more than its cash, and less than half the value of AT&T.

And Capellas' new Net services won't generate enough sales to compensate for plunging telecom revenues anytime soon. The company's sales are expected to drop 17.4% this year, to $16.9 billion, according to UBS Securities (UBS ), after a 16% decline in 2004. "It is not going to be easy financial sledding for Capellas," says one telecom consultant who has done work for MCI. Among the most likely acquirers are the Bells, possibly SBC Communications (SBC ) or BellSouth (BLS ), and a foreign telecom player, such as British Telecom.

One reason Capellas may come up short is that his competition promises to be grueling. Tech service giants IBM (IBM ) and Accenture Ltd. (ACN ) have been pitching corporate tech departments to let them manage their applications for years. Networking-equipment makers such as Juniper Networks Inc. (JNPR ) and Cisco are embedding security into their own gear to protect corporate computers. And archrival AT&T (T ) is pursuing a strategy that's similar to MCI's -- and it's ahead on several fronts. AT&T already is offering its own computer security and software hosting services. "MCI doesn't have much chance competing head to head," says analyst Melanie Posey of market researcher IDC.

Capellas is unfazed. He's racing forward with plans to upgrade the company's 100,000-mile network, a project expected to cost $500 million over the next two years. Some customers already are buying his pitch. Northbrook (Ill.)-based insurance giant Allstate Corp. (ALL ) is wiring new offices with Web phones and plans to tear out all of its old analog lines by 2007. It selected MCI to handle its telephone business because of its reliability and customer service and expects to save 3% annually on its phone bills. The company plans to hand over computer security to MCI in the near future. "If only one person handles it, the cost goes down," says Allstate Chief Technology Officer Catherine S. Brune.

Capellas recognizes the tradeoff of his repositioning. MCI is going to become a smaller company, but he firmly believes he will be able to return it to profitability within the next few years. "That's the price of poker," he says. He expects software hosting and security to deliver profit margins that are twice those of basic voice and data transmission. Analyst John Hodulik of UBS Securities says MCI could even make a very small profit in 2005.

For now, Capellas' lofty goals have lifted the cloud that has hung over MCI since predecessor WorldCom went belly-up in 2002. In November, Capellas wound up a 26-city, 30-day tour to pitch employees on the makeover. On stressful late nights shaping that plan, Capellas and crew took to singing karaoke. Their favorite lyrics: "I get knocked down, but I get up again," from British band Chumbawamba's Tubthumping.

Capellas and his team will need all the perseverance they can muster. As they try to deliver on MCI'S new strategy, the traditional phone business is evaporating and potential acquirers are circling. Sure to take more lumps, MCI is fighting hard to get back on its feet.

By Brian Grow and Catherine Yang in Ashburn, Va., with Roger O. Crockett in Chicago

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