From Bad To WorseJul 2, 2002 | The Economist Global Agenda
REGULATORS investigating the huge book-keeping fraud at WorldCom have accused the company of not disclosing all the details of the scandal which is gripping corporate America. Auditors are also examining other financial records, which could add another $1 billion or so to the $3.8 billion hole already discovered in the firm's account.
WorldCom now stares bankruptcy in the face. Its stock, which was once worth $66 a share, tumbled to a derisory 6 cents when trading in WorldCom resumed on July 1st. WorldCom could be delisted from the Nasdaq market on Friday. The firm also gave warning that it had received notice from some of its lenders that they could demand immediate re-payment of loans.
A sworn statement made by WorldCom about the affair was heavily criticised by the Securities and Exchange Commission (SEC) for its lack of information. “WorldCom's statement is wholly inadequate and incomplete,” said Harvey Pitt, the chairman of the SEC.
The statement was largely a timetable of events. It said an internal audit discovered an irregularity, which a subsequent investigation found to involve $3.8 billion-worth of costs which had been wrongly classified as capital expenses over a five-quarter period from the start of 2001. The statement added that the audit committee is now reviewing WorldCom’s financial records for 1999 and 2000.
After Enron, and with other scares about corporate scandals continuing, President George Bush has said that he is worried about the economic fallout. He has reason to worry. The scandals have shaken investor and public confidence in American capitalism. Mr Bush is preparing to announce new policies to protect shareholders and punish unethical executives, according to government officials. These could be announced in a speech Mr Bush is due to make on Wall Street on July 9th.
The mess that John Sidgmore, WorldCom’s new boss, revealed last week is being investigated by KPMG, which replaced the firm’s long-standing external auditors, Andersen (yes, them), in May. Unlike costs, capital expenses are written off against profits over time, so the error by WorldCom boosted its reported cashflow and profits. WorldCom reported a profit of $1.4 billion last year, and $130m for the first quarter of 2002. These numbers were, in fact, fictitious and should have shown a big loss.
So far, most people are blaming Scott Sullivan, WorldCom’s chief financial officer until he was sacked on June 25th. The House Financial Services Committee has subpoenaed Mr Sullivan and a number of the firm’s other executives to appear at a hearing on July 8th. This include Bernie Ebbers, WorldCom’s founder, who was often to be seen in his cowboy boots and stetson hat. He was forced out of the company in April and had been under pressure to raise WorldCom’s sagging share price. Mr Ebbers owes WorldCom over $400m, which he borrowed to bet on WorldCom shares. These loans are secured on Mr Ebbers’s personal assets, including a yacht-sales company, a soyabean farm, and nearly 27m WorldCom shares.
The entire board had a strong motive to keep up the share price. Between them, the 12 directors and executives named in the company’s latest proxy statement, filed in April, own nearly 50m WorldCom shares. Even the outside directors are big owners: Max Bobbitt, a telecoms consultant who chairs WorldCom’s audit committee, has nearly half a million shares.
Mr Sidgmore will now have to rethink his tactics. The company had been hoping to negotiate a $5 billion bank loan, in part to refinance a $2.65 billion loan on which it is now in default (because its accounts no longer comply with GAAP standards). These negotiations now look doomed. That leaves liquidation or restructuring as the main options. Nancy Kaplan of Adventis, a telecoms consultancy, thinks that any attempt to restructure WorldCom will fail. The company is good at selling data and other telecoms services to its corporate customers. This is a business with real margins and growth prospects. But it has lots of weak businesses as well, including its declining consumer long-distance unit and its failed mobile-telecoms arm. This makes it harder to shrink, despite a series of recently announced layoffs.
The more likely outcome, says Ms Kaplan, is that WorldCom’s competitors will pick off its assets at bargain prices. These include thousands of miles of “backbone” fibre-optic cable, which runs between cities, together with WorldCom’s efforts to upgrade the “last mile” underneath cities so that businesses can connect to this broadband network. Both have problems. The capacity glut in backbone fibre persists. And the patchwork of networks that run beneath the world’s big cities lacks scale and is plagued with technical problems. Top of the list of buyers ought to be AT&T, WorldCom’s only serious competitor in the business-services market. In the present environment, however, it is hard to see how AT&T is going to raise the money to buy anything.
It is these sorts of “doom loops”, says Bill Bane of Mercer, a consultancy, that prevent investors from seeing the bottom for the telecoms industry. Two things could change that. One, says Mr Bane, is if the fibre-optic capacity glut turns into a supply shortage. Although Enron made markets in it, fibre-optic backbone is not really a fungible commodity. Customers who want to send data from New York to London cannot use the pipe that goes to Washington, DC. That leaves any pair of destinations vulnerable to a capacity shortage.
Also forgotten in the current industry rout is that demand for fibre-optic cable is growing by 75-150% every year. Mr Bane foresees a scenario in the not-too-distant future in which big companies find that their delicate, just-in-time, global electronic supply chains seize up. That will cost them huge sums of money, prompting them to buy or lease their own private, global fibre-optic networks from the telecoms companies. This, of course, would tighten the supply squeeze. Prices would soar. If it were still around, WorldCom might then once again be worth hundreds of billions of dollars.
The other possible outcome is that WorldCom, AT&T and other telecoms companies that serve business customers are absorbed into the Baby Bells, the local telephone operators that the regulators hived off from AT&T in 1984. These bureaucratic, sleepy near-monopolies have found favour with investors recently. America’s regulators and antitrust officials have, until now, viewed their expansion into other markets with caution. After its turbulent experiments with deregulation, however, America craves stability from its all-too-excitable telecoms companies. The Baby Bells could certainly supply that.