WorldCom Accounting Scandal: The Wrong Call (Part 1)

From its beginnings as a long distance call player to handler of Internet data traffic, WorldCom was a spectacular firework in the sky before it crashed out as one of the biggest bankruptcies America has witnessed in its corporate history.

WorldCom carried more international voice traffic than any other company. It carried a large amount of the world's Internet traffic. WorldCom owned and operated a global IP (Internet Protocol) backbone that provided connectivity in more than 2,600 cities and in more than 100 countries. It also operated 75 data centres on five continents.

WorldCom reached the spot of the largest long distance provider and Internet data traffic player largely through acquisitions – 65 of them. The company spent $60 billion in acquisitions and had $41 billion in debt between 1991 and 1997. Starting from pennies a share the company steadily climbed to selling at $60 a share in 1990.

Of its many acquisitions two were of particular importance.

  • The MFS Communications acquisition which helped WorldCom to obtain UUNet, a major supplier of Internet services to business.
  • The acquisition of MCI communications that made WorldCom one of the largest providers of business and consumer telephone service.

Soon WorldCom became the darling of Wall Street, with several recommendations from analysts to buy. This helped WorldCom in the way that they could make more acquisitions, by using stock. By acquiring MFS Communications WorldCom was adding data services and local services in their basket of long distance services. MCI a strong player in the long distance communications arena, helped consolidate WorldCom’s position in the market. WorldCom had acquired MCI after a competitive bid by British Telecom for $18 billion. WorldCom offered $30 billion in its stock and took $5 billion of MCI’s debt.

WorldCom had made its large 65 acquisitions in the span of just 6 years. Mergers and acquisitions are tricky business. The integration with the acquiring company has to be done at several levels, with the staff and the numbers at both the firms being in sync over time. Managements have to do this exercise tactfully and persistently to achieve one whole. At the end of it the acquisitions must add to shareholder value. Typically, financial integration must take place using GAAP or general accounting practices so that the financial practices, methods of viewing profit, debt across the acquired companies are seen through the same lens.

WorldCom unfortunately did not take the task of integration with the same alacrity and enthusiasm as acquiring them. WorldCom’s CEO Ebbers while making the right broad strokes with his brush, did not take the time to etch out and work out the finer details of operations. The acquired entities continued to behave separate of WorldCom. The supposed benefit of merging was lost with the first line of employees critical to projecting a whole entity, customer service botching it up badly. The different teams of customer service continued to be rewarded for aggressive sales at the cost of each other.

WorldCom closed three important MCI technical service centers that contributed to network maintenance only to open twelve different centers that were duplicate and inefficient.  WorldCom purchased a large number of local exchange carriers or clercs to provide local service. All the capacity was expensive and severely underutilized, introducing a high degree of redundancy into the system.

The financial reporting was creative at its best. WorldCom would write down in one quarter millions of dollars in assets it acquired while, at the same time, it included in this, charge against earnings the cost of company expenses expected in the future to give an impression that profits were rising. This gave the impression that while losses were high in the current quarter the losses appeared to reduce in the forthcoming quarters.

In the case of MCI, WorldCom reduced the book value of some MCI assets by several billion dollars thereby increasing the value of "good will," that is, intangible assets brand name by the same amount. This enabled WorldCom each year to charge a smaller amount against earnings by spreading these large expenses over decades rather than years. The net result was WorldCom's ability to cut annual expenses, acknowledge all MCI revenue and boost profits from the acquisition.

With regards to accounts receivables WorldCom put up many of MCI’s receivables for sale. This resulted in creating a smaller reserve for bad debts and therefore higher earnings.

Then WorldCom attempted to acquire Sprint, another major player in the long distance call market. This deal was not allowed on the basis that it would create a monopoly, wherein the play of market and competitive forces would not be allowed to function.

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