TELECOM INDUSTRY POLLUTED BY WORLDCOM FRAUD

Tim McElligott
July 1, 2002 12:00 PM

WorldCom reported last week that a routine audit uncovered $3.8 billion in misapplied expenses over the last five quarters, which new CEO John Sidgmore said “were not made in accordance with generally accepted accounting principles.” That understatement, followed by an expected restatement of the company's earnings, has analysts calling financial bankruptcy a forgone conclusion for the carrier. The moral bankruptcy that caused it has investigators calling for heads and WorldCom customers calling the competition.

Sidgmore, who took over the company when former CEO Bernard Ebbers resigned under pressure in April, told investors in a prepared statement last week that “I pledged to restore your trust in this great company, and part of this trust-building exercise means being forthright about communicating problems when we discover them and being proactive in correcting them.”

Such action is one saving grace that in the long run may separate WorldCom from scandalized companies such as Enron, Tyco and ImClone, according to Stuart Gilman, president of the Ethics Resource Center in Washington.

“As disastrous as this is, there really is a ray of light here because the company's own board of directors blew the whistle,” Gillman said. “They caught sight of the problem, took responsibility and stepped forward.”

But it's a small step on a very long road to restored trust. Along the way, WorldCom also must establish financial viability and salvage its brand while surviving an investigation that got underway last Thursday as the House Financial Services Committee summoned Ebbers, Sidgmore, dismissed Chief Financial Officer Scott Sullivan and Salomon Smith Barney analyst Jack Grubman for a July 8 hearing.

Guzman & Co. analyst Patrick Comack said it will be hard for the Clinton, Miss.-based carrier to avoid bankruptcy. “WorldCom is dependent on the banks providing the credit facility, and it will be very difficult for them to do that given WorldCom is in such a penniless position.”

Others said it is possible for WorldCom to emerge from bankruptcy if only because of the size of the company and its importance. “Both the government and the banks have a vested interest in keeping them afloat,” said Glen Macdonald, vice president at Adventis. If restructuring saves just a tenth of WorldCom's billions of dollars of debt, the banks save hundreds of millions of dollars, he said.

While WorldCom is busy restructuring, its customers will be busy protecting their own interests. “WorldCom's brand has been severely damaged by this, and they should immediately lose share to AT&T, Sprint and Qwest. In the long term, RBOCs will be the real beneficiaries,” Comack said.

Most analysts, however, don't expect an immediate mass exodus of WorldCom's enterprise customers, for two reasons: Most large businesses are already diversified in their networks, and, more important, they are locked into long-term contracts with WorldCom. But they do have to be ready just in case.

EDS, one of WorldCom's largest customers, said in a statement that “EDS will closely monitor the situation and is prepared to and will act to ensure the interests of EDS and its clients are met.”

Sidgmore tried to salvage customer faith. “Customers can continue to count on WorldCom to meet their communications needs today, and they can count on us tomorrow,” he said in his statement last week. “Our dedication to our customers is unwavering.”

Starting this week, however, there will be 17,000 fewer dedicated employees to support those customers. Sidgmore said downsizing will save WorldCom $900 million annually. But it could cost the company millions in market share.

“You can expect AT&T and Sprint to start moving in for the kill, and they are in a position to do that,” said Courtney Quinn, senior analyst of telecom strategies for The Yankee Group.

Both AT&T and Sprint said customers are moving on their own. “In the long run, these sorts of things are not good for the industry,” said Mark Bowser senior vice president of sales for Sprint. “However, [Sprint] is seeing an increased level of interest from potential customers, particularly [those] from WorldCom.”

An AT&T spokeswoman said the company saw more enterprise customers move to its network during the recently completed second quarter because of concern for their current providers, which are not limited to WorldCom.

While some carriers issued statements expressing “dismay,” as Sprint did, Adventis' Macdonald said further condemnation was unnecessary.

“Why pour salt on the wounds? They are winning just by the fact that WorldCom is losing. Even if it emerges from bankruptcy, it will be a smaller, weaker player, and the windfall will go to more conservative telecom companies.”

Still, transitioning a complex network is time-consuming and complicated. Analysts and carriers agreed that initially, enterprises will position themselves for transition if necessary.

“Tier 1 [carriers] have been a pretty safe haven until recently, so nobody likes to diversify,” said Brownlee Thomas, analyst at Giga Information Group. “But they are going to have to.”

How much of the market WorldCom can retain depends on its ability to restore itself financially and ethically.

“What makes our society run is not the laws,” said Gilman. “It is the common, shared sense of values that we all hold in terms of integrity, honesty, respect and trust. What is lacking in the capital markets today is not profitability; it's trust.”

Sidgmore vowed that WorldCom is “committed to operating in accordance with the highest ethical standards.”