Experts: WorldCom headed into bankruptcy protection
By Thor Valdmanis and Andrew Backover
USA Today
U.S. Bankruptcy Court may be the only refuge for WorldCom.
After disclosing what could be one of the biggest accounting frauds in corporate history, the nation's No. 2 long-distance provider has set off a chain of events that could see it filing for Chapter 11 bankruptcy court protection within months, if not weeks.
During a conference call yesterday morning that lasted less than an hour, 21 creditor banks met to discuss the potential impact of WorldCom's Tuesday disclosure that it improperly accounted for $3.9 billion in costs, people close to the situation say. That appears to have put WorldCom in default on a $2.65 billion bank loan.
Led by Bank of America, the bankers agreed to set up a creditors committee that will ultimately decide whether to pull the plug on Corporate America's latest disgrace.
WorldCom is "in a death spiral," says Gartner analyst Ken McGee. Adds Tim Horan, telecom analyst for CIBC World Markets: "It is almost a certainty that WorldCom goes bankrupt."
To survive even that, WorldCom would have to pull off a Houdini act that will somehow placate alienated employees, disgusted investors, terrified clients and angry lawmakers.
On top of that, it will have to tiptoe through a minefield of civil and even criminal lawsuits. The Securities and Exchange Commission set off the barrage yesterday, filing charges of fraud against the company. Lawmakers promised probes, lambasted regulators and talked about jail for lawbreakers.
Even more disturbing, WorldCom's accounting shenanigans further weaken confidence in the nation's capital markets, already diminished by Enron, Andersen, Global Crossing, Adelphia, Tyco and ImClone. They have also revived cries for accounting reform. "If there was fuel on that fire before, we are now talking about napalm," says Lisa Pierce of Giga Information Group. "This has ramifications throughout Corporate America."
Fallout from the scandal has already largely wiped out shareholders and threatens to spread to banks, customers, debt holders and suppliers. It also raises new doubts about the bookkeeping of rival Qwest Communications, also under SEC review.
With $104 billion in assets, WorldCom would be the biggest bankruptcy filing ever. "This is the straw that broke the camel's back," says Robert Willens, accounting analyst at Lehman Bros. "The investors I'm talking to are so disgusted, they are throwing in the towel. People simply can't trust corporate financial statements."
Once a Wall Street darling that came out of nowhere to buy long-distance giant MCI and almost land Sprint before regulators blocked the deal two years ago, WorldCom was widely seen as a world-beater. But the pressure to grow through acquisitions — even while profits from core businesses atrophied — may have proved too much. Instead, WorldCom inflated its cash flow by $3.9 billion over the past five quarters. Rather than charging certain costs, which may have been for wages to workers in maintaining telecom systems, it called them long-term investments. That let WorldCom inflate earnings, because long-term investments are subtracted from earnings over time, not right away as is required for ordinary costs.
So, instead of earning more than $1.5 billion during those quarters, analysts estimate it lost at least that much. With its books in question, WorldCom's efforts to negotiate a $5 billion credit line with banks are dashed, people close to the situation say. Instead, WorldCom will likely have to enter into discussions over how much debt it can get lenders to trade in for equity in a restructured company before filing for bankruptcy.
WorldCom CFO Scott Sullivan has been sacked, and controller David Myers resigned Tuesday. In April, CEO Bernie Ebbers, who owes the company $408 million, was forced to resign as WorldCom's performance deteriorated.
People close to the situation say the accounting scandal emerged last week when WorldCom internal auditors told former auditor Arthur Andersen that they were having trouble reconciling WorldCom's books. When questioned, Sullivan and his controller admitted they had not briefed Andersen about key decisions. He allegedly admitted that, at the end of each quarter, he changed the books so that more assets were written off over longer periods of time. Sullivan spent a frantic weekend trying to develop a rationale for his accounting, arguing to the board that since WorldCom was investing in networks that would produce future revenue the expenses could be spread out over longer periods.
New auditors KPMG didn't buy the explanation and instead demanded a restatement Monday night, the people close to the situation say. WorldCom board members agonized over the situation but during a meeting Tuesday voted to fire fellow board member Sullivan and take their findings to the SEC.
One 'bad apple?'
The scandal had tongues wagging from the White House to grandma's house. That's because WorldCom, founded as a start-up in Mississippi in 1983, had grown into a cultural as well as corporate icon with a base of 20 million consumers. Unlike energy trader Enron, WorldCom and its MCI unit are major consumer brands. Major concerns — including Nasdaq Stock Market — count on WorldCom to move data.
While President Bush and Capitol Hill leaders expressed outrage, weary investors could do little. Nasdaq halted trading of shares of the WorldCom and MCI tracking stocks before the market opened — but after WorldCom shares dropped to 10 cents on trading on Island Electronic Marketplace — down from a high of $64.50 in 1999.
Many analysts believe some WorldCom executives could face prison. This "is far from the work of one bad apple," says Howard Schilit, founder of the Center for Financial Research and Analysis. "This is a case of many bad apples at the core of the company."
The repercussions could spread to:
—Banks. Dozens of creditor banks, such as Bank of America, Citigroup and JP Morgan Chase, which have lent WorldCom billions, could suffer. While some declined comment, most banks declared that their exposure was minimal and not material to overall earnings. Nevertheless bank shares took a hit Wednesday.
—Accounting firms. Once again, former Enron auditing firm Arthur Andersen finds itself in the middle of a huge restatement. The firm signed off on WorldCom's financial statements until it was fired a month ago. Late Tuesday, Andersen issued a statement saying that CFO Sullivan had deceived the firm. Sullivan could not be reached. Meanwhile, the SEC is examining the books of other Andersen telecom clients, Global Crossing and Qwest.
—Suppliers. WorldCom expects significant cuts in capital spending this year and next, meaning less money to buy switches and fiber-optic gear from the likes of Nortel and Lucent. Lucent shares fell 20 percent to $1.58 Wednesday. Nortel dropped 9 percent to $1.47. The regional Bells, which get paid by WorldCom to begin and end long-distance calls, could also suffer, says J.P. Morgan analyst Marc Crossman.
—Customers. Concerned about declining service quality, up to 20 percent of WorldCom's large and midsize business customers are likely to switch to other carriers as their WorldCom contracts expire in the next six to nine months, analysts say. That will likely help AT&T and Sprint the most. Having fewer bidders could led to higher prices, analysts say.
—Audit committees. WorldCom's bombshell occurred under the watch of its audit committee — typically composed of a company's strongest board members. The four-person committee met five times last year, but was informed of the accounting discrepancies by an internal auditor last week, sources close to the company said. None returned calls Wednesday. "Audit committees have to be stronger," says corporate-governance attorney John Harkins.
—Rivals. Qwest tried to distance itself from WorldCom's scandal with a statement from new CEO Richard Notebaert. "What has happened at WorldCom is unfortunate for our industry. However, Qwest is a different company, and I wouldn't be here if I didn't believe that," he said. Qwest shares, which hit $64 two years ago, crashed 57 percent to $1.79.
Even those who stand to benefit from WorldCom's woes suffered. Sprint, the No. 3 long-distance carrier, saw its shares fall 10 percent to $10.10. Shares of No. 1 AT&T fell 3.3 percent to $9.62.
A brave face
While WorldCom's fate seemed to spin out of its hands, new WorldCom CEO John Sidgmore tried to reassure antsy employees. The company tomorrow will lay off 17,000, or 21 percent of its workforce, in a bid to save $900 million annually. He says the new developments won't hurt its cash position this year and that it has enough cash on hand.
Analysts say Sidgmore's recent ascent — he replaced Ebbers on April 29 and had a limited daily role as vice chairman before that — could help the company regain integrity and investor trust.
"I still remain optimistic about WorldCom's future and am wholly committed to the company, our customers, investors and, especially, to you, our employees," Sidgmore said in an e-mail to employees yesterday.
