MCI Group, one of the two tracking stocks that emerged from Worldcom two months ago, has been a disaster so far, falling to 13 from 20 despite an enormous dividend yield that now stands at over 18%.
MCI's travails ought to produce some scrutiny of the split-up, in which MCI was allocated a heavy debt load of $6 billion and forced to make certain payments to Worldcom Group, the dominant tracking stock that accounts for over 95% of the combined companies' valuation.
MCI, for instance, is paying Worldcom Group $27.5 million this year for use of the MCI name and that expense will rise to $45 million by 2005. This galls MCI fans partly because Worldcom has done all it can to eliminate MCI from its corporate name. MCI also pays Worldcom a premium of 1.25 percentage points on its allocated debt, roughly $75 million a year, based on the higher borrowing costs MCI would pay as a standalone entity. Under the tracking stock structure, neither Worldcom nor MCI is independent. Both remain under the parent,Worldcom Inc., which is responsible for all debts.
Some investors suspect that the high MCI debt load, the interest-rate premium and the trademark charge are part of an effort by Worldcom Chief Executive Bernie Ebbers to improve the financial profile of Worldcom Group and thus facilitate a sale of Worldcom to one of the Baby Bells. Worldcom has been mired around 14, down from a 1999 high of over 60. There's speculation that Ebbers wants to get 25 to 30 a share for Worldcom, a sizable premium to the current price. Looking at the two trackers, Worldcom's market value is $43 billion while MCI's value is just $1.5 billion. Given that MCI is viewed as a wasting asset, there's incentive for Worldcom to shift costs and debt to MCI.
The Dow industrial rose 96 points, or 0.9%, to 10512, in the week, helped by gains in Intel, Microsoft and IBM. The index now is down 2.5% so far this year.
MCI holds some of Worldcom's least desirable businesses, including its consumer long-distance and wholesale operations, while Worldcom retains the higher-growth data and Internet backbone businesses. During the split-up, Worldcom holders got 1/25 of a share of the MCI tracker for each Worldcom share.
MCI has been hurt by disappointing June quarter results that have raised doubts about the sustainability of the juicy annual dividend of $2.40. Management stated in the earnings release that the company aims to pay the dividend for the "foreseeable" future but wasn't more specific. Following the MCI profit news in late July, Merrill Lynch analyst Adam Quinton cut his 2001 profit estimate, excluding goodwill amortization, to $3.99 from $4.87 a share and his 2002 estimate to $3.12 from $4.12. MCI's revenues are falling at a double-digit rate, but its costs are rising -- a bad combination.
Worldcom, meanwhile, trades for around seven times projected 2001 pre-tax cash flow, in line with the multiple on SBC Communications, Verizon Communications and BellSouth. But Worldcom's price/earnings ratio is much lower than the Baby Bells. Worldcom trades for 12 times projected 2002 cash earnings, against an average P/E of 16 on the Baby Bells. Why the disparity? Worldcom takes lower depreciation expense than the Bells and also capitalizes more interest.
Qwest Communications fell 3.50 to 24.40 last week, after hitting a new 52-week low of 23, on heavy volume amid concerns about several issues, including rival Global Crossing's disappointing profit report, Qwest's ability to hit its ambitious double-digit revenue growth goal for this year and 2002, and earnings and revenue quality. There also was speculation that BellSouth was selling part of its 52-million share stake in the company.
Qwest, which includes the fiber assets of the Qwest and U.S. West, the old Rocky Mountain Baby Bell, peaked at 60 a year ago. Qwest's sell-off prompted positive comments from some analysts and investors, including Marc Crossman of J.P. Morgan, who argued that the U.S. West piece of Qwest is worth $21 a share, putting an effective floor under the stock around current levels. Qwest now trades for around seven times projected 2001 cash flow, in line with the multiples on the Baby Bells, yet is expected to experience stronger revenue and cash-flow growth than the Bells.
BellSouth, which held 52 million shares of Qwest earlier this year, was rumored to be selling part of that stake on Thursday, when Qwest fell two points in active trading. BellSouth couldn't be reached. In January, BellSouth sold 22 million shares of Qwest back to the company, and agreed to hold 41 million of its remaining 52 million shares for at least a year. The talk is that BellSouth may have parted with half its salable block of 11 million shares last week. If it did sell, BellSouth took a loss, since its cost was around $50 a share.
The ability to shuffle debt and in-terest costs under a tracking stock structure is most pronounced under the Sprint umbrella, where Sprint PCS, the wireless tracking stock, bears a disproportionate cost relative to Sprint FON, the tracker that reflects the local, long-distance and data divisions of the company.
Sprint FON is allocated just $4 billion in debt, while Sprint PCS has been apportioned $14 billion. Sprint PCS effectively pays a rate of nearly 8% on its debt, nearly two points more than the actual cost of Sprint's total debt. As the company's latest 10Q spells out, "the difference between Sprint's actual interest rates and rates charged to the PCS Group is reflected as reduction in the FON Group's interest expense."
During the first quarter, these savings to the FON group were $64 million, cutting its interest expense to $27 million. When those savings are annualized and adjusted for taxes, Sprint FON realizes a benefit of about 20 cents a share. That's a sizable chunk of the company's expected profits of $1.20 a share this year. Sprint FON trades for 23 and Sprint PCS fetches 25, both way below 2000 peaks.
Why shift interest to the PCS tracker from the FON tracker? Sprint PCS gets valued by Wall Street based on pre-tax cash flow before interest expense, while Sprint FON gets valued by many investors on after-tax earnings. |
