Tracking the Trouble Caused by WorldCom's Bernie Ebbers
By Jerry Knight
Washington Post Staff Writer
Monday, March 18, 2002; Page E01
Seems like every day lately, Washington investors find a new reason to wish they'd never heard of Bernie Ebbers.
Bernard J. Ebbers, chairman of WorldCom Inc., has managed to turn two of the most innovative technology companies in Washington history into two of the worst investments in the region.
Shares of Digex Inc., a pioneer in the business of hosting Web sites, once were worth more than $30 a share. Since WorldCom acquired Intermedia Communications Inc., which controls Digex, the stock has skidded to $1.42 a share from about $10.
MCI Communications was the star of Washington's telecommunications industry before being acquired by WorldCom. Since Ebbers came up with the idea of creating a separate tracking stock for WorldCom's Washington-based MCI Group last summer, the shares have plunged to $8.02 a share from $22.50.
The twin tracking stock of WorldCom Group has done almost as badly, falling from $17.85 to $7.40.
The two WorldCom stocks dropped sharply last week after it was revealed that the Securities and Exchange Commission is conducting a sweeping investigation of accounting practices at WorldCom, whose auditor just happens to be Arthur Andersen.
Based on the list of documents the SEC is demanding from the company, the probe sounds all too familiar. Service swaps with other companies that may have inflated the revenues of both firms. Potential hanky-panky in accounting for acquisitions. Possible double counting of revenue. Questionable write-offs of bad debts.
In all, the SEC is asking about 24 different topics. Some are targeted down to the 14th subparagraph, leading to speculation that insiders have tipped off the SEC on what to look for. Some are stunningly sweeping, including "all documents created or reviewed by WorldCom's COOs, CEOs, CFOs, Controller or Board of Directors and all committees thereof concerning."
You get the message. Turn on the Xerox machines. Unleash the paralegals. Then rent a couple trucks and haul it all over to the SEC.
In statements, the company has said it has done nothing wrong, has nothing to hide and doesn't know why the SEC started its investigation.
One thing that probably unleashed the watchdog is in item No. 21 on the SEC's shopping list, which takes dead aim at Ebbers himself. The SEC is demanding "all documents concerning loans made by WorldCom to any of its officers." That would include the $341 million loan the company gave the chairman last month to bail him out of his bad investments.
While part of the reason that WorldCom and MCI stocks are down is that the telecommunications industry is in the tank, at least as much of the blame belongs to Ebbers.
The plan he came up with last year to create separate stocks for the MCI long-distance part of the company and WorldCom's Internet services was a loser from the beginning. The company did not actually split in two. Instead, Ebbers created what are called tracking stocks for the MCI Group and the WorldCom Group.
The price of the MCI Group tracking stock is supposed to reflect how that part of the operation is doing. Ditto for the WorldCom side of the operation. The trackers trade on the Nasdaq Stock Market, under the symbols WCOM and MCIT.
The tracking stock concept has been around for years and is based on the premise that the sum of the parts is worth more than the whole company. The financial engineers who came up with tracking stocks contend the markets simply don't understand complicated companies. Create separate tracking stocks and Wall Street will reward you with a higher value, they promised.
It has almost never worked. Circuit City Stores Inc. tried it in 1997, creating a tracking stock for its CarMax auto dealerships. Predictably, the performance of the CarMax tracking stock and Circuit City's shares has been disappointing. They trade as KMX and CC on the New York Stock Exchange. A few weeks ago, Circuit City announced it will abandon the tracking stock experiment and will spin off CarMax into a separate company, with actual shares.
The flaw in the tracking stock theory is that investors seem to have even more trouble understanding tracking stocks than they do understanding companies with diversified businesses.
I predicted last summer that WorldCom's tracking stock scheme would fail to "enhance shareholder value," just as almost all others had. Ebbers responded in a letter to the editor that the criticism was "based on the performance of dissimilar tracking stocks and a narrow view of business prospects."
"The employees of the MCI Group welcome the opportunity to exceed the predictions that fall so severely short of our potential and, more important satisfy the expectations of the many investors who share our belief in a prosperous future," he wrote.
The shares of the MCI and WorldCom tracking stocks began to fall on the first day of trading and have never added up to what WorldCom stock was worth before it was bifurcated.
The false promise of the financial engineers is not the only reason for that. Since last summer the financial performances of both parts of the company have deteriorated. Sales of the WorldCom Group fell 9.6 percent to $5.3 billion in the fourth quarter, and profit was down 42 percent to $347 million. The MCI Group's sales slid 16 percent to $3.18 billion, and the group, which had a fourth-quarter profit of $125 million the previous year, posted a loss of $89 million.
The company's weakening profits started the stocks' slide last year, and the decline accelerated in the past few days after it was disclosed that the SEC launched its investigation of WorldCom's accounting practices. MCI Group's stock fell 18 percent last week; WorldCom Group's fell 19 percent.
The SEC probe also has driven down the value of the billions of dollars of bonds issued by WorldCom, which the Bloomberg financial news service ranks as the sixth-largest borrower in the U.S. bond market.
In a single day last week the price of a WordCom bond with a $1,000 face value plunged from $912 to $868. At that price, the WorldCom bonds, which were issued carrying a 7.5 percent interest rate, are yielding 9.71 percent. That's high. The yield is only 7.41 percent on some General Motors Corp.'s bonds that mature at about the same time.
Those numbers suggest the bond market calculates that the chances of not getting paid when you buy WorldCom bonds is roughly 30 percent greater than the chances of not getting paid by GM.
Call it the Bernie Ebbers discount.
Is it fair to blame it all on Ebbers? Absolutely. It's his company, as much of a one-man show as a $35 billion a year business can be.
Ebbers built WorldCom into what it is: one of the nation's biggest telecommunications companies, the outfit whose fiber-optic cables connect the 19 million customers of America Online, link together all the Federal Aviation Administration's air controllers and provides similar communications services to thousands of other customers.
Ebbers built the company with acquisitions, starting with a few little phone companies that hoped to profit from deregulation and ending with the acquisitions of UUNet and MCI, two of the most successful and important telecoms in Washington – except for AOL Time Warner.
If there was ever any doubt that WorldCom is Ebbers's baby, it was dispelled by the loan the company gave him last year when he got a margin call from the brokers who lent him more than $250 billion using his WorldCom stock as collateral.
Other founders have lost control of their companies after making the mistake of mortgaging their personal stock. It happened to William Schrader, who created PSINet Inc. It happened to Robert Kopstein, founder of Optical Cable Corp. of Roanoke. It didn't happen to Ebbers because he used WorldCom as his personal piggy bank.
The company generously agreed to lend Ebbers all the money he needed to cover his debts and to lend it to him at a bargain rate – about 2.15 percent. That is less than half the prime rate charged by banks, which is 4.75 percent, and well below what he could borrow the money for from any brokerage house.
That's what it costs WorldCom to borrow, company officials say, so it's only fair to charge the chairman the same rate. It's not fair to stockholders, however. Charging Ebbers the going rate would take $15 million to $20 million out of his pocket and put it into stockholders' pockets, giving the company a badly needed revenue boost.
The company also argues that bailing out Ebbers is good for shareholders. That, unfortunately, may be true. When Kopstein was forced to sell his controlling interest in Optical Cable to meet margin calls last year, the stock plummeted from $8 to around $1 and has never come back.
Kopstein, however, controlled about 90 percent of Optical Cable's stock and liquidation of his holdings flooded the market. Ebbers's holdings are closer to 1 percent of WorldCom's outstanding stock. Selling Ebbers's shares would dampen the market, but not drown it.
Giving loans to corporate executives always is an affront to ordinary shareholders and Ebbers's loan is one of the biggest ever, according to the William M. Mercer Inc. The firm scoured through company reports for the Wall Street Journal and found no other executive loans of more than $15 million.
Don't blame me, Ebbers told Maria Bartiromo of CNBC last week. "I was asked not to sell my stock by the company, and I did that," he said.
It'll be interesting to see whether that answer satisfies the SEC. So far in the flap over the Bernie bailout, no one has asserted that it is illegal, only that it is wrong.
The loan, alas is not the only thing WorldCom has done lately to protect its chairman. Earlier this month, the company adopted a "poison pill" takeover defense that makes it all but impossible for anyone to buy WorldCom unless Ebbers and his hand-picked board of directors go for the deal.
That too was done, not for his benefit but for the shareholders, Ebbers insisted on CNBC. "We didn't do it to make it harder for other people to come at us," he said. "Since 1983, when we started the company, we've been for sale."
The poison pill, he said, was fed to WorldCom by its investment bankers, whose research of the subject "clearly showed that people that have poison pills . . . get a better result for their shareholders. That's the reason we did it."
Ebbers's defense of the poison pill may be hard for shareholders to swallow. But it can't be much worse than swallowing the 47 percent drop in WorldCom stock since the first of the year.
© 2002 The Washington Post Company |
