WorldCom Inc.: survival at stake.

Gollakota, Kamala ; Gupta, Vipin

CASE DESCRIPTION

The primary subject matter of this case concerns management of mergers and acquisitions in a turbulent environment. Secondary issues examined include strategic, organizational, and competitive issues that push the companies to the brink of destruction, and that may induce them to breach the boundaries of ethics and accountability for remaining afloat. The case has a difficulty level appropriate for first year graduate level. The case is designed to be taught in 1.5 class hours and is expected to require 2 hours of outside preparation by students.

CASE SYNOPSIS

Accounting fraud issues have taken the center stage whenever there is a discussion about the bankruptcy of WorldCom. However, the fraud issues were just an outcome of a deep-rooted deterioration in the performance fundamentals of WorldCom. In this case, we discuss some of the strategic, organizational and environmental issues that led to the survival challenges, and hence precipitated ethical irregularities and downfall of the company.

INTRODUCTION

Considerable attention has been focused on WorldCom in recent months. WorldCom has the dubious distinction of being the company responsible for the biggest accounting fraud and bankruptcy in the US till date. It may be tempting to view WorldCom mostly as an example of how unethical behavior leads to bankruptcy. However, to do that would miss out on a major lesson in management. An analysis of the company's performance shows that the company was having severe problems even before the accounting fraud issue surfaced. Had the company stayed on that trajectory, it might be speculated that it would have moved into bankruptcy sooner or later. WorldCom suffered from strategic and organizational dilemmas and was in an industry facing tremendous turbulence. The aim of this case is to identify the strategic, organizational and environmental issues that led to the decline of WorldCom.

CHANGE AND THE TELECOMMUNICATIONS INDUSTRY

The foremost characteristic of the telecommunications industry is one of change. The twin drivers of change have been technology and regulation/deregulation. Traditionally telecommunications meant communicating by telephone and historically one company provided the service: AT&T. AT&T was considered a natural monopoly and controlled all aspects of telephony: local, interstate and international long distance. However, in 1963, MCI filed with the FCC to be allowed to provide communication services. In 1969, MCI was granted permission to do so, and started voice transmission over microwave links between St. Louis and Chicago. Other companies followed suit but competition was hampered because of AT&T's control over the local exchanges. In 1984, AT&T was ordered to breakup. The long distance business was created as a separate company and retained the AT&T name. Long distance telephone services were opened up to competition while the local exchanges were still monopolies. The local exchanges (connections to millions of individual homes)--RBOC's (Regional Bell Operating Companies) were created into 22 separate holding companies. Each RBOC served between 12 and 20 million customers and reported assets in excess of $20 billion. These local exchanges were required to give access to the long distance companies to reach individual homes through their network (for an "access fee": fees paid by long distance providers to local exchanges to transmit the long distance call to the homes of the customers). Numerous companies jumped in to offer long distance services--WorldCom was one of these.

WORLDCOM ENTERS THE MARKET

In 1983, WorldCom was launched under the name LDDS--Long Distance Discount Service by Mississippi businessmen Murray Waldron and William Rector. Its business was to resell long distance phone service. The company ran into difficulties by 1985, and Bernie Ebbers, who had invested in the company became its CEO. Ebbers would lead the company through its meteoric rise and even faster fall. The company expanded beyond its base in Mississippi and went public in 1989. In May, 1995, LDDS changed it name to WorldCom.

Ebbers, originally a high school basketball coach who moved to Mississippi from Canada was managing a chain of motels. When he took over LDDS, he had no background in telecom. Wearing faded jeans, cowboy boots and turquoise jewelry he described his organization as "Our personality is to be very loose. We aren't stuffed- shirt people" ("Bernie's Deal," 1997). However, he was an aggressive businessman, and a compulsive deal maker. His vision of growth was by acquisition. Major acquisitions included Advanced Telecommunications Corporation (a long distance reseller which gave it access to its business customers), Metromedia Communications Corporation and Resurgens Communications group (both full service long distance providers), IDB Communications group (which in addition to a having domestic and long distance telephone network, had facsimile and data connections, television and radio transmission services and mobile satellite communications capabilities) and Williams Telecommunications group (WilTel), (which came with 10,000 miles of fiber and 1000 miles of microwave technology). One of WorldCom's most significant acquisitions was of MFS Communications. MFS came with local network access facilities via digital fiber optic cable network and most important, owned UUNET technologies. UUNET was a leading internet provider that catered primarily to business customers.

The pattern underlying these acquisitions and mergers seems to be an attempt to obtain end to end ownership of the networks. Many of these companies were similar to WorldCom in that they were entrepreneurial start ups. Majority were in markets with high growth, and WorldCom often paid top dollar to own them. With these acquisitions WorldCom transformed itself from a patchwork of regional long-distance resellers into a network of facilities-based service providers, competitive local exchange carriers and backbone network operators. By 1996, it had revenues of $5.4 billion and was the fourth largest provider of long distance services in the US with a strong internet presence. Its competitors in the long-distance telephony arena included AT&T, the largest, with $47 billion in annual revenue, followed by MCI with $15 billion annual revenue, and Sprint with $14 billion in annual revenue. The top four telephony companies (AT&T, GTE, BellSouth, and NYNEX) accounted for 60 percent of all telephony--local and long distance--revenue dollars.

Although WorldCom was growing rapidly with its acquisitions, problems were emerging in the telecommunications industry. At the cost end, the RBOC's who provided local service ("the last mile"--providers of service between the home/office and the long distance company's switches), continued to have monopolies. Although local access was mandated by the FCC, access charges (charges paid by the long distance telephone company to the local telephone company) were high. Long-distance carriers typically paid 30 to 40 percent of gross revenues for local origination and termination of long-distance calls. High access fees and allegations of non-cooperation from local exchange companies in getting access to the local networks, were common complaints from long distance providers. Price pressures were felt because of increasing competition, low switching costs and the increasing commoditization of long distance service. The price of long distance calls dropped sharply, while the price of local calls rose. These developments prompted the Telecommunication Act of 1996.

THE TELECOMMUNICATION ACT OF 1996, CONVERGENCE AND UNPARALLELED DEMAND

The Telecom Act of 1996 resulted in further deregulation of the industry. Under this Act, long distance carriers were allowed to provide local phone service (including by setting their own facilities and thereby avoid paying high access charges). Further, local carriers were required to make individual components of their networks available at wholesale prices to the resellers. Local carriers who opened their networks to competition were allowed to offer long distance services. This Act cleared the way for a whole range of competitors. There were two business models: operate as a facilities-based provider or operate as a reseller. Facility based providers invested in laying the communications lines and networks. Resellers, however, did not need to expend capital on laying lines, but could lease the networks of the provider and resell these to consumers. While resellers had been around even before the Telecom Act of 1996, the Act of 1996 required the facility-based carriers to provide access to the resellers at wholesale prices (Oliver, 1997).

In 1993, the FCC had cleared the way for telephone companies to enter the information services business, including computer data services, financial services, stock quotes, and news reporting. They were also permitted to deliver video services, although like the cable companies, they could not own the program content. Even though the telephony market structure shifted from a monopoly to an oligopoly, on the eve of the 1996 Act, there was little product differentiation. Differentiation was usually an illusion created by varying small, nonessential aspects of a product or service. The Act of 1996, however changed this and created the possibility for telecom companies to fully control the new value added services from end to end, by entering both local as well as long-distance markets, and thus gain an effective capability for product and service differentiation. Two significant technological advances fuelled this optimism in the industry: digital transmission with the increased performance of fiber optic cable (that allows large amounts of data to be transmitted--making video transmission possible) and the boom in internet. Rapid internet growth rates of the order of 750 to 1000% annually had been projected and endorsed by WorldCom ("Too many debts; too few calls--The telecoms crisis," 2002). This concept of convergence--the possibility that data, voice and video could all be offered by a single provider to a household, and the surge in demand with new entertainment possibilities was the dream of many telecommunication. Telecommunication firms scrambled to build the groundwork to be the provider of choice. Investors viewed telecom as the wave of the future, and the backbone for the 21st century world economy that could sustain accelerated growth in revenues and profits. With the stock market boom, and easy money available, telecom companies seemed poised to take off. Telecom was deemed the hottest industry on the eve of the MCI-WorldCom acquisition.

It was in this atmosphere, that WorldCom made an offer to purchase MCI.

ACQUISITION OF MCI

MCI was a company with a longer history and had pioneered in opening up the telephone market to competition by filing an anti-trust suit against AT&T in 1974. After entering the long distance business, MCI started constructing a coast-to-coast fiber optic network. Unlike WorldCom, that started as a reseller and grew by acquisitions, MCI grew from within and gained market share by various marketing innovations such as "Friends and Family". By 1997, MCI was the second largest long-distance carrier in the US. Although it had experienced good growth, the pressures of the long distance business, had started affecting its performance.

British Telecom was looking for ways to enter the US market and was planning to acquire MCI. Since 1993, British Telecom had 20% stake in MCI and was in the process of acquiring the balance 80% of MCI. However, BT reduced its initial offer of $23 billion to $17.9 billion in August 1997, based on revised information. US telecom industry's long distance revenue growth was expected to slow down considerably. MCI performance had also dropped. Most importantly, losses in local-market business were running at $800 million in 1997--twice what MCI had expected ("WorldCom tucks in--again," 1997). This drop in BT's offer opened the door for other bidders. Both WorldCom and GTE wanted to buy MCI and were bidding for MCI. WorldCom's offer of $37 billion beat the $28 billion all cash offer of GTE, and valued MCI at twice the BT's offer.

WorldCom's acquisition of MCI in 1997 was incredible in many ways. At that time, WorldCom was a little known company and MCI was the second largest long distance carrier--a company many times the size of WorldCom. This acquisition was the largest merger in US history till that point. There was great euphoria and this deal was commended by the media with phrases like "Why WorldCom + MCI adds up. At Last! A "Deal Of The Century" That's Smart" (Kupfer, 1997: 35).

WorldCom justified its doubling of BT's bid because it expected twice the synergies compared to BT. First, the combined company will have all the pieces of the modern telecom network--local, wireless, long-distance and internet access, and a broad market coverage nationally and internationally, and for business and residential customers. WorldCom (through its subsidiary UUNet) was the world's biggest carrier of Internet traffic, which was growing very rapidly. Further, WorldCom was the number 4 long distance provider and MCI was the number 2 long distance provider, which jointly provided 25% share in the US long distance market--compared to 54% of AT&T, down from 62% in 1992 (Elstrom, Barret, & Yang, 1997: 26). WorldCom had local fiber optic assets in 96 US cities, which would save MCI the 45% fee it had to pay the Baby Bells for using their networks. MCI had special strengths in the residential market, while WorldCom had been focused almost exclusively on the business customers. WORLDCOM also had a mass of undersea fiber that would help MCI long distance business to offer better global connections. The merging of the systems was expected to cut the firms costs by $2.5 billion in the first year, and by $5 billion in the 5 years following. Half these savings were to come from using each other's networks to route their customers internet and phone traffic saving on leasing costs (Yang & Elstrom, 1999). Mr. Sidgmore, WorldCom's CFO, stated that underlying similarities in design made merging the networks easy (Yang & Elstrom, 1999).

The rest of the synergies were foreseen to come from the decrease in overhead from 30% of revenues to 23% (Yang & Elstrom, 1999). The acquisition would allow both firms to benefit from using MCI's large sales force. WorldCom, which had a reputation for running a tight ship could rejuvenate MCI which had become rather stodgy (a shift from its days of challenging the system under McGowan) and help it transition to a long distance business design, that was becoming increasingly commodity type and price based. On the other hand, MCI had a reputation for marketing innovations and WorldCom could leverage its brand name and the marketing savvy of MCI's executives. At the same time, WorldCom also expected that it could fix MCI's "management problems" by providing strategic direction to MCI. Strategic mistakes by MCI included its aborted purchase of Nextel Communications, a wireless firm, on-off alliance with Rupert Murdoch's News Corp in 1995 and not investing in networks. Moreover MCI had been pumping money into the video-on-demand market that has been a tech blind alley. On the whole, acquisition was expected to benefit shareholders--in the '90's MCI's shares returned an average annual return of 4.3%, while WorldCom had a return of 55.8% ("WorldCom tucks in--again," 1997). Post-acquisition, the combination of WorldCom's local business assets with MCI's long distance assets was predicted to result into a cost savings of $20 billion over five years (Business Week, 1998).

A comparison of the combined companies vis a vis their competitors is given in Table 1.

The acquisition was completed on September 14th 1998 and the new company was called MCIWorldCom. During 1999 and 2000, MCIWorldCom acquired about a dozen companies related to a variety of web-based services. Most prominent of these were Skytel Communications, a provider of one way messaging services, acquired in 1999; and Intermedia Comm acquired in September 2000 for $6 billion (Elstrom & Mandel, 2000).

STRATEGIC CHALLENGES

Though the scale and scope of business opportunities presented by the acquisition were unprecedented, realization of the anticipated synergies was also an unparalleled challenge. There were two major concerns. First, WorldCom had grown through 50-odd acquisitions since 1992, and was still in the process of integrating several of its acquisitions: Brooks Fiber Properties that gave it local phone assets, MFS that turned it into the nation's largest Internet-backbone operator, and CompuServe's high-speed networking division CNS. Its core competency lay in deal making, focused on buying companies, largely for their sales force and customer base, and growing profits by cutting overhead and transferring the customers and their traffic onto WorldCom's network (Mehta, 2001). It was not known for developing new products and services or for customer care and service, and had followed a strategy of follower, not an early mover. Its primary stated mission was to make the company appealing to a potential acquirer, such as an overseas carrier looking for a presence in the US or to a regional telephone company striving to grow beyond its local territory, and materialize an ultimate deal yielding huge returns to WorldCom's shareholders (Mehta, 2001). MCI, on the other hand, took pride in product innovation, and had grown essentially through internal development. The anticipated synergies from the acquisition were based on the premise that MCI's product innovation capability could be transferred to WorldCom's high growth businesses, while WorldCom's cost control capability would fit MCI's maturing long distance market. Thus while the acquisition gave WorldCom a large scale of broad scoped telecom assets unparalleled in the industry and there were potential synergies, the two companies needed to be integrated to realize these synergies.

Second, at a strategic level, despite its numerous acquisitions, WorldCom's portfolio had numerous weaknesses. The combined company was more dependent on the long distance business, and therefore faced stronger risks from the regional Bells' anticipated moves into the long distance business (Upbin, 1998). Further, while WorldCom had resale rights to wireless, it avoided taking ownership of wireless assets--instead adopting a wait and watch approach until the customer ownership of cell phones becomes huge (Mehta, 2001). In contrast, its smaller rival Sprint already had a healthy blend of local, long distance and wireless assets, with strong global alliances. The fast-growing wireless business was at the core of Sprint's growth strategy, and a critical part of AT&T's plans.

Finally, the company had to make the largest non-treasury bond issue in US history, valued at $6.1 billion to pay cash to British Telecommunications for its 20% stake in MCI. It also had to establish short-term bank debt and commercial paper of $15 billion to finance the post-acquisition integration and investments in August 1998 (Garrity, 1998). Consequently, its balance sheet was under pressure, looking less healthy compared to its major rivals-- Sprint and AT&T.

ORGANIZATIONAL CHALLENGES

Following the acquisition, Ebbers, started to "shape up" the culture of MCI. To bring about the necessary efficiencies, three of MCI's corporate jets were sold. Company cars were eliminated for everyone except Ebbers and Bert Roberts, MCI's former Chairman. In July 1988, Ebbers called MCI's top executives for a powwow in Florida. Here Ebbers announced new austerity measures. Instead of corporate jets and first class comfort, that MCI executives were used to, they had to fly discount airfares and rent cars instead of limos. Hotel room limits were reduced from $200 per night to $59.00 per night and executives were encouraged to share rooms. Business lunches over $5.00 would need receipts (in the past it was $25.00) and these executives were to submit monthly revenue statements that would be personally reviewed by Ebbers. In the strangest move of all, water coolers disappeared from MCI's corporate office in December 1998. Such cost control measures were felt throughout MCI. By March 1999. 2,215 people were laid off. In terms of marketing, a major policy shift was instituted. MCI had a culture of expensive sales promotions and gaining accounts big-name accounts for brand building. Now the policy was to change to based on whether these projects brought in money (Yang & Elstrom, 1999). As these austerity measure were being put into place many MCI executives left or were replaced, including the marketing executives credited with MCI's prior marketing successes (Hoover, 1998). The Wall Street Journal reports that as many as 70% of MCI executives left the firm following the austerity measures after the acquisition (Pelliam, 2002). As in some other telecom mergers, combining the two networks was more difficult than anticipated and the quest to add value was elusive

ENVIRONMENTAL TURBULENCE

These strategic and organizational problems were exacerbated by changes in the industry environment. Between the time when the Telecommunications Act of 1996 was passed, and 1999, 147 resellers entered the market. Although reselling typically has razor thin margins, and is not a very profitable business, the existence of resellers greatly constrained the power of facilities based long distance providers (like MCIWorldCom) to increase prices. Competition was intensely price based and prices per minute fell rapidly, on average by 10%, between 1997 and 2000 (Elstrom & Mandel, 2000). In 2000, there were more than 500 long-distance providers, with prices as low as 3 cents a minute for big corporate customers (Haddad, 2000). MCIWorldCom's share of long distance business stood at 25% in 2000 (Haddad, 2000). With 43% of its total revenues coming from the long distance business in 2000, MCIWorldCom was squeezed at the revenue end.

At the cost end, the Baby Bell companies who provided local service has relatively high access charges (charges paid by the long distance telephone company to the local telephone company). The deregulation of this sector started later, but proceeded very slowly, putting cost pressures on the long distance providers. In 2002, WorldCom estimated that it pays hundreds of Local Exchange Carriers a total of $750 million a month for local access, interconnection, billing, and other services. On the other hand, Local Exchange Carriers purchased services from WorldCom worth only $455 million per month, for offering long distance services to their customers ("Local Carriers Battle WorldCom in Court For Payment, Right To Terminate Service," 2002). Consequently, the fundamentals of voice communication business deteriorated faster than expected.

The euphoria in terms of increasing bandwidth continued. Between 1998 and 2001 the amount of fiber in the ground increased five-fold. Technological advances in the capacity of fiber increased the transmission capacity of fiber 100-fold. So actually total transmission capacity increased 500-fold. However, the entertainment boom and other applications of this technology did not keep up as expected. During the same period demand increased only 4-fold ("Too many debts; too few calls--The telecoms crisis," 2002). This created massive imbalance between supply and demand. The high debt coupled with high marketing expenditures in expectation of the projected revenues squeezed the industry operating margins. With 20% of its 1999 revenues, or $7.5 billion, coming from carrying data on internet backbone, and another 10% of its revenues ($3.5 billion) coming from providing Internet access to the corporate customers, MCIWorldCom had to drastically cut down its overall growth and profit projections as a result. Compared to MCIWorldCom, AT&T derived only 12% of its revenues from Internet/data and Sprint derived 16% from this segment. They, as well as other major rivals, had stronger focus on wireless business and web-based services.

There was not much better news in the internet business which did not grow as fast as expected. As wireless technology improved and wireless services became more widely used, consumers increasingly switched from wired to wireless services. The trend accelerated in the year 2000 as mergers & acquisitions contributed to formation of strong wireless players, resulting in cost savings and attractive promotions such as free handsets with 12 to 24 months of wireless service contracts. In July 2000, the merger of GTE and Bell Atlantic created the largest US wireline and wireless operations, named Verizon Telecommunications. SBC Communications acquired Bell South to take 2nd position in wireless. AT&T wireless dropped from the dominant position in early 1999 to No. 3 by mid-2000. Sprint took the 4th position in wireless business, backed by a marketing alliance with Radio Shack that gave its wireless products instant national distribution.

The earlier uncertainty about wireless was getting resolved with the technological strides made in wireless technology. Wireless service was increasingly used as a marketing tool by bundling it with other services like long-distance telephone and Internet under discount one stop packages (Advertising Age, 2000). Also, value-based wireless services, such as wireless-based internet access or wireless-long distance telephone call transfer, gave an additional edge to the telecom firms that had strong wireless positions. Therefore, firms like MCIWorldCom that did not have a strong wireless segment began losing customers in all their businesses to the wireless majors.

ATTEMPTS TO ENTER WIRELESS AND THE FAILED ACQUISITION OF SPRINT

MCIWorldCom sought to fill the major hole in its portfolio of businesses--that of not having a strong base in wireless--by proposing to acquire Sprint, whose wireless unit had a national coverage and a good depth in several major cities. Sprint's wireless assets would allow MCIWorldCom to offer high-speed wireless connection directly to the local customers. MCIWorldCom offered $129 billion for Sprint's combined wired and wireless operations, a 50% premium over Sprint's then stock valuation (Titch, 2001). However, regulatory agencies in Europe and in the US joined forces against the proposed merger. Although the combined company would be smaller than AT&T in the long distance business, it was expected that in some long distance markets there would be a duopoly (Krapf, 1999). Further, with MCIWorldCom being focused primarily on very high density business accounts in urban areas, the merger with Sprint would further deter development of voice services in rural and residential properties. More importantly, the combined operations would create an unhealthy concentration of internet operations. MCIWorldCom was the dominant player in the Internet backbone business, and given the immense significance of internet to the current US economy, its acquisition of Sprint, which held 8% share in the Internet-backbone business, would deter competition. Sprint offered to spin off its internet-backbone business into a separate business unit to facilitate its merger with MCIWorldCom. MCI had to earlier sell its Internet assets for $1.75 billion to UK-based Cable & Wireless to gain regulatory approval for merger with WorldCom. The difficulties of separating voice backbone from the Internet backbone meant that MCI failed to separate and share the business customer list and to transfer most employees in the Internet backbone business to Cable & Wireless. In March 2000, MCI was ordered to pay $200 million in damages to Cable & Wireless (Jones, 2000). However, with the Cable & Wireless experience on record, the US Department of Justice rejected the merger. The market reacted strongly to this setback and WorldCom's stock price fell sharply. The stock was no longer a viable currency for big acquisitions, and the debt levels reached unsustainable proportions (Titch, 2001). Its balance sheet looked distinctively unhealthy: by the end of 2000, the long-term debt of WorldCom had grown to $20.7 billion, from $13.1 billion a year earlier. Revenues, on the other hand, had grown from $37.1 billion in 1999 to just $39.1 billion in 2000 (Titch, 2001).

With failure of the bid to acquire Sprint, WorldCom, now MCIWorldCom, reasoned that most of the growth would have to come through internal development, and that web-based services offered the best prospect for such growth.

STRATEGIC REFOCUS?

By late 2000, MCIWorldCom realized its post-merger strategy of combining disparate businesses: consumer and corporate oriented businesses, long distance and Internet business, price-sensitive business and service oriented business would not be effective for entering the higher value-added web-services business. To allow a proper focus in November 2000, MCIWorldCom was partitioned into two groups: WorldCom and MCI. Although both of these are not separate legal entities and are still owned by WorldCom Inc., they would be tracked separately. The WorldCom group would focus on high-end data services, Internet, Web-hosting, providing total solutions, international and commercial voice businesses; and MCI group would consist of the consumer, small business, wholesale long distance, wireless messaging and dial-up Internet access businesses. In general the business and commercial customers were assigned to WorldCom while the retail (consumer) and small business was assigned to MCI. The MCI group was allocated an expense and the WorldCom group was allocated a corresponding decrease in costs for the use by the MCI group of the fiber optic systems and buildings, furniture, fixtures and equipment attributed to the WorldCom group. The businesses attributed to the MCI group accounted for 41.8% of revenues, 38.0% of net income and 14.8% of assets for the year ended December 31, 2000 (Worldcom, 2001). The company also expressed its intention to spin-off MCI group to a suitable buyer, should it receive an attractive offer, and identified the WorldCom group as the focus of its future growth. Though the company recognized that the internet backbone and data business growth is falling sharply below previous expectations, it still rejected the concern the data business is becoming a commodity like voice long distance. In November 2000, Ebbers reasoned that "offering data is much more complex than providing voice" (Barron's, 2000). This split would also serve to provide investment funds which were becoming increasingly hard to come by and was in line with other companies in the industry spinning of parts of their company. The telecom industry raised more than $40 billion in initial public offerings of those spun off high-growth operations in 2000, and additional $60 billion was expected to be mobilized in 2001 (Elstrom & Mandel, 2000).

WorldCom identified two major assets that would support rapid growth in web services (Haddad, 2000). First, its vast, global network of 300,000 miles of fiber optics, that carried 50% of the world's Internet traffic. This network could deliver faster, digital Internet access and other web services, such as the industrial-strength web site design and management, to corporate customers with whom it had good relationships. Instead of just carrying data on its internet backbone, the thrust would be to offer premium services such as storing, enhancing, and manipulating data, the market for which stood at $37 billion in 2000. Second, its 40 million long distance phone customers could be encouraged to pay for the breakthrough value-added services, such as browsing the Web by speaking into their phone. MCIWorldCom earmarked $100 billion, including $9 billion in 2000, for developing its Internet backbone into a mega internet computer, to break into and rapidly grow the web services market. It believed that the mega internet computer concept would allow it to attack wide range of web service opportunities all at once, and would give it a dominant advantage despite the presence of strong early mover competitors in various sub-segments of web services. The critics, however, remained skeptical of MCIWorldCom's ability to grow into a full-service Internet provider, given its penny-pinching culture, lack of innovative spirit, and poor record of customer service, holding that "delivering service on Internet time" is alien to WorldCom's culture (Haddad, 2000). Although this would later be restated, in 2001, WorldCom group showed a revenue increase of 11% from 2000. MCI group however experienced a decline of 16% in revenues--primarily on account of the substitution by wireless (Worldcom, 2002). Consumer revenues declined 9 percent to $1.7 billion. Wholesale revenues declined 19 percent to $591 million. Alternative channels and small business revenues declined by 29 percent to $531 million. Dial-up Internet revenues declined by 15 percent to $344 million.

TOWARDS BANKRUPTCY: 2002

By the end of 2001, telecommunications companies in the US had added massive capacity in networks, backed by $400 billion of debt over 1997-2001, based on an idea that the world was about to experience a huge wave of demand for data traffic, and that their brand new networks would be needed to carry that data. Ironically, however, those predictions sowed the seeds for their own downfall, prompting a further wave of investment which left the telecom industry facing chronic overcapacity and unrealized revenues--a problem accentuated by the general economic downturn (Mehta, 2002). New revenue generated per investment dollar was expected to be 26 cents, down from 42 cents in 1998 and 34 cents in 2000 (Elstrom & Mandel, 2000). Compared to capital spending surge of 25.5% annually since 1996, telecommunications revenues grew only 10.5% per year--much below the persistent projections of 15% growth annually. Return on assets dropped from 12.5% in 1996 to 8.5% in 2000 (Elstrom & Mandel, 2000). Competition got worse when a whole new set of competitors stepped in--powerful firms with deep pockets: Cable and Utility companies.

The intensely competitive nature of the industry is evident when we consider the numerous bankruptcy protections that were being filed. Teligent, McLeod USA, Metromedia Fiber Networks, and Nextlink filed for Bankruptcy protection. Global Crossing, a fiber-optic network company under federal investigation for accounting fraud, was also under bankruptcy with debts of $12.4 billion. Similarly, $26 billion debt-ridden Qwest Communications, a phone and Internet carrier, was also under federal investigation for accounting fraud, and was feared to be on the verge of bankruptcy (Bergstein, 2002).

The stock price of WorldCom continued the downward slide that started with its failed acquisition of Sprint and was its lowest in seven years--down 88% from its April 1999 peak (Mehta, 2002). Adding to the bleak industry situation, and slowing growth of WorldCom were rumors about financial impropriety. Pressures inside the company had been mounting and it was reported that three star employees were suspended and at least 12 others had their commissions frozen over an order-booking scandal (Smith & Solomon, 2002). In March 2002, SEC started investigating the accounting practices of WorldCom including personal financial benefits extended to the CEO-Ebbers received $408.2 million in low 2.32% interest loans from WorldCom to cover margin calls he made on company stock (Black, 2002).

Events moved very rapidly after this. Continuing pressures in its business led to massive layoffs when 10% of its employees were laid off and the firm slashed its revenue projections for 2002 by a billion dollars. Ebbers resigned as CEO following this. Moody's dropped WorldCom's debt status to "junk". In the hope of saving dividends associated with the MCI stock, WorldCom eliminated its MCI tracking stock (Smith & Solomon, 2002).

On 25th June 2002, WorldCom admitted that it needed to restate its accounts for 2001 because of some accounting irregularities. WorldCom had booked $3.8 billion of expenses (charges paid to local telephone networks to complete calls) as capital expenses. By moving these ordinary expenses to the capital account, it could show lower expenses, greater profits and amortize the capital expenses over a period of time in the future. This transformed WorldCom's bottom line from a loss for all of 2001 and the first quarter of 2002 into a profit (Sandberg, Solomon, & Blumenstein). This disclosure led a complete collapse in the share price which was already very low. Trading in WorldCom's stock was halted on 26th June and the SEC filed civil fraud charges against the company. Less than a month later, WorldCom, squeezed by suppliers who demanded upfront payments, was forced to file the biggest bankruptcy in corporate history on July 21st. Further problems came up--in early August, 2002, the ongoing internal review of accounts unearthed additional inflated profits of $3.3 billion starting in 1999. Restatement of accounts would then wipe out profits for year 2000. The company warned that more irregularities might surface. The company might also need to take a write off of goodwill to the order of $50 billion. In mid-September, additional accounting improprieties of $2 billion surfaced, involving accounting issues that in the past were open for interpretation--such as merger and acquisition accounting and asset write downs (Thal Larsen, 2003). Eventually, with nearly $11 billion of irregularities, there were serious concerns as to the whether the company's performance during the tech boom was really just based on accounting gimmicks. During the ongoing investigation of WorldCom's accounting practices, it emerged that some employees in the company were concerned about these accounting misstatements and had taken it up with their superiors, but were pressured not to pursue the matter (Dreazen & Solomon). In late September 2002, some high-ranking executives pleaded guilty to falsifying accounting data on instructions from senior management (Cohon & Solomon, 2002).

SURVIVING IN THE FUTURE

While some analysts are skeptical about ability of WorldCom to recover from the loss of its credibility and goodwill, WorldCom still has some very valuable assets. The communication fiber owned by WorldCom is 95,000 miles long, covers 65 countries and carries much of the world's internet traffic including 29% of the traffic in USA. WorldCom has long term contracts it has signed with many large multinational companies and governments. Through MCI, WorldCom has access to 20 million telephone customers. Finally, the numerous small acquisitions it has made along the way that were never really integrated into its operations would be useful assets (Kessler, 2002).

WorldCom expected to continue its operations, and emerge revitalized from bankruptcy as a "vital counterbalance" to the Bells' dominance of local telephone markets. It planned to have 3 million local customers by the end of 2002, and offer its "The Neighborhood" all-distance calling plan in all of the Lower 48 states by the first quarter of 2003 ("WorldCom Bankruptcy's Effect on Telecom Market Debated," 2002).

Several analysts began asking if it is fair for the companies like WorldCom to be allowed to revive. They worried that as the unethical, debt-burdened companies are allowed to reorganize under bankruptcy and shed their debt obligations, they would gain an unfair competitive advantage over still solvent and ethically managed companies, and force the latter to follow the suit. Ivan Seidenberg, chief executive of Verizon, was "on fire--fire-engine-red mad" that his company, with $59 billions in debt, might have to compete with some companies that use bankruptcy to clear their huge debt obligations. Verizon spokesman Eric Rabe held, "Fundamentally, what you have is companies using bankruptcy arbitrage to fund their business model". "For those of us who pay our debts, that's grotesquely unfair." (Bergstein, 2002)

In addition, though it was felt that the $10 trillion gross domestic product US economy will be able to weather the WorldCom bankruptcy, concerns remained about the effects on those who do business with telecoms. Nearly 60 public telecom companies filed for bankruptcy court protection in the 19 months from 2001 to July 2002 (Swartz, 2002). Fallout from the telecom implosion was on pace to be the USA's biggest financial debacle. Several leading banks were among the WorldCom's top creditors: JP Morgan was owed $27 billion; Citibank, $3.3 billion; Bear Sterns, $2.7; Morgan Stanley, $1.9 (Swartz, 2002). After the banks, WorldCom's biggest creditors were regional telephone companies that sell WorldCom access on their networks so that WorldCom can complete customer phone calls and data transmissions. WorldCom owed hundreds of local exchange carriers $750 million in monthly billings. SBC, Verizon and BellSouth were asking the Federal Communications Commission to protect them from future telecom bankruptcies by requiring bigger upfront deposits from carriers such as WorldCom. However, in view of the dire state of the telecom companies, FCC was reluctant to accept the demand for upfront deposits. Most of the USA's 1,200 small phone companies had a business relationship with WorldCom, accounting for 5% to 10% of revenue (average monthly payment: $12,500), because the small carriers charged WorldCom's MCI to start and finish calls in their territories. The survival of several of these companies was now also on stake. Further, with WorldCom operating in 65 nations, foreign telecom outfits were also being squeezed. Videsh Sanchar Nigam, India's main international long-distance and Internet provider, wasn't been paid access fees by WorldCom for last several months, accumulating arrears of more than $100 million (Swartz, 2002).

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Kamala Gollakota, University of South Dakota Vipin Gupta, Grand Valley State University

Table 1: Comparison of Major Long Distance Companies (1999 estimates)

 AT&T MCI WorldCom Sprint

Total Customers 80 million 22 million 20 million
Consumer Voice $21.7 billion $6.9 billion $2.8 billion
Business Voice $16.4 billion $14.1 billion $5.6 billion
Total Voice $38 billion $20.9 billion $14 billion
Data/Internet $7.7 billion $11.0 billion $2.8 billion
Wireless $6.7 billion N/A $2.9 billion
International $1.1 billion $1.8 billion N/A
Other $8.3 billion $378.0 million $287 million
TOTAL $61.9 billion $34.1 billion $20.1 billion

Source: Sanford C. Bernstein & Co. (1999).