Life Among the Ruins:
The Impact of WorldCom
Scott B. MacDonald
Last week WorldCom's
board of directors dropped a bomb in the form of financial fraud.
The company stated that it capitalized $3.9 billion of expenses
in 2001 and $797 million in Q1 2002 instead of listing them on
the income statement as operating expenses. The result of this
"transfer" is an overstatement of EBITDA by a parallel amount
in each period. The CFO, Scott Sullivan, was fired, as was David
Myers, the controller. The CEO, John Sidgemore, indicated that
WCOM still hopes to remain an ongoing business. He also announced
a new set of measures: a workforce reduction of 17,000; the selling
of non-core assets; paying preferred dividends in stock; and continuing
discussions with the banks for a badly needed new credit facility.
Bankruptcy is a major concern for WorldCom's bond and equity holders.
Although the stock market bounced back, the WorldCom bomb is also
a blow to the confidence in the U.S. economy and has implications
for other countries, especially those who rely upon exports and
whose currencies are not tied to the dollar.
We see six major results
from the WorldCom scandal. First and foremost, the negative perception
of corporate America has only been reinforced. Investors already
have developed a destructive sentiment vis-a-vis corporate management,
accountanting firms, lawyers and investment banks. One of the
jokes making the rounds after WorldCom is that CEO no longer stands
for Chief Executive Officer, but Chief Embezzlement Officer and
that EBITDA now means Earnings Before I Tricked Dumb Auditors.
WorldCom clearly reinforces the lessons learned from Enron and
Arthur Andersen and bolsters a negative perception about the U.S.
corporate world during a period of time in which the economy is
struggling to maintain momentum. Consequently, investors in Wall
Street are fleeing anything that is remotely similar to WorldCom
or other troubled sectors, such as energy and utilities (both
of which were tagged by Enron). Banks, which lent money to all
of these companies, are also under scrutiny by nervous investors.
The second result of the
WorldCom scandal is that the government is moving to re-regulate
the economy. Ironically it is a Republican administration that
is moving to tighten controls over accounting, corporate governance
and transparency and disclosure. While this is likely to reduce
chances of corporate wrongdoing, it will also add layers of regulations
on businesses that will be more costly in terms of time and money.
The WorldCom scandal is likely to become an election issue in
the upcoming fall 2002 congressional races, with the Democrats
seeking to paint the Republicans as the friends of big sleazy
business. This could prove difficult since the Clinton administration
sat in the White House through the most exciting years of the
bull market on Wall Street.
The third result is that
WorldCom's customers are likely to leave it in large numbers.
Who will benefit? AT&T is the most likely first choice for
most enterprise customers seeking a relatively sophisticated network.
After AT&T, the mostly likely candidates are Sprint and Qwest
(which has its own set of problems).
A fourth result will be
a reexamination of U.S. telecom policy. This is complicated as
the Securities Exchange Commission sees WorldCom as one of the
worst accounting scandals in history and will want to take enforcement
action of considerable harshness. The Federal Communications Commission
is likely to be more open to letting the company be sold to a
rival, including one of the former Baby Bells. This would help
remove WorldCom as an ongoing crisis.
The Department of Justice
is also involved because of the anti-trust issue. It is no secret
that several Bells have looked at buying WorldCom, largely for
its position in the Internet backbone and enterprise markets.
At some point in a bankruptcy proceeding, those assets might be
attractively priced for a Bell. However, since the Justice Department
not too long ago broke up Ma Bell, there are serious questions
about allowing Bell's to buy WorldCom assets. Sadly, other long
distance companies are in no condition to buy WorldCom, leaving
the Bells as the only real possibility. All of this means U.S.
telecom policy must be reconsidered and quickly. As Legg Mason's
equity analysts Blair Levin and Michael J. Balhoff noted: "Over
time, however, we think an additional and critical story will
emerge: we believe that the fate of the company, and to a significant
extent, the larger telecommunications sector, is in the hands
of the government."
The fifth result is that
WorldCom and the other scandals are weakening the dollar. As foreign
investor confidence in the U.S. corporate sector declines, due
to concerns about management sleaze, two things could happen.
One, foreign investors, with an eye to the slumping value of the
dollar, could demand a premium to hold U.S. securities. Two, they
could also demand a premium for credit risk. Both trends would
only accelerate the dollar's declining value in international
markets. In addition, there is little confidence in U.S. Treasury
Secretary O'Neill ability to manage the dollar. His off the cuffs
remarks that Brazil was not worth throwing in more U.S. taxpayers
dollars, while perhaps reflecting common sense, were disastrous
to an already spooked market. The danger with the dollar is that
O'Neill believes that market forces should be left to run and
if so, the dollar plummets, he will seek to turn the situation
too late in the day. Foreign funds flow into the United States
is not to be casually dismissed considering that the U.S. needs
to it help finance its current account balance of payments deficit,
which is expected to be around 5% of GDP, a large number.
The sixth factor and closely
related to number five is the impact of WorldCom beyond U.S. shores.
Firstly, the sleaze element is already giving impetus to greater
regulation and better corporate governance in countries such as
Canada and the United Kingdom. Second, WorldCom as well as the
earlier Enron scandal, are hurting the attractiveness of the so-called
Anglo-American model of de-regulated capitalism and giving greater
credence to a capitalism modified by a larger state role in the
economy (Germany and France). Third, as WorldCom weakens foreign
investor sentiment on U.S. securities, this feeds into a weaker
dollar. This would be bad news for countries who rely upon exports,
and whose currencies are not tied to the dollar.
The 1990s was a decade
characterized by the bull market, the advance of new technologies
and business management techniques, an erosion of corporate governance
and accounting standards and easy big money in the stock market.
In many respects, the rising tide of new IPOs and euphoria over
the "new economy" raised all boats. The tide appears to have gone
back out. The 2000s are shaping into a decade of bear market runs,
a tightening of accounting and corporate governance standards,
and difficult to achieve profits on Wall Street. No doubt other
corporate scandals are lurking, which will reinforce the negative
trends. Yet, it is important to remember that the vast majority
of U.S. companies are not corrupt, many are beginning to return
to profitability, and tighter standards will lead to better transparency
and disclosure. The U.S. still remains one of the safest places