Bernie Ebbers blew it, and under board pressure has resigned as CEO of WorldCom. Now there is almost zero chance of saving his baby.
With $28 billion in burdensome debt, WorldCom is wavering on the precipice of bankruptcy, and Qwest, owing its own 25 big ones, doesn’t seem far behind. To make matters worse, both are forced to compete with already bankrupt companies resurrected with no effective debt.
How did we get to this sorry state? Me, I blame Mr. Ebbers for the whole telecom mess. Starting with a long-distance company, Mr. Ebbers went on a buying binge using his inflated stock as currency. IDB WorldCom, an international long-distance company was bought at the end of 1994, followed by WilTel, a carrier’s carrier, in early 1995. A year later, Congress passed the quasi-deregulating Telecommunications Act, issuing Mr. Ebbers a hunting license to bag trophies beyond long distance.
Multiple Personalities
In August of 1996, Mr. Ebbers bought MFS Communications which ran fiber to office buildings in dozens of cities. With MFS came UUNET, the hot Internet access company that Bill Gates and Steve Case fought over to invest in, but that MFS stole from them both. In one deal, Mr. Ebbers created what the world heralded as the new phone company, combining local, long distance and Internet access, naming it WorldCom. What more could you want? WorldCom’s stock started 1990 around a split-adjusted $1 and ended 1996 over $17.
But like Cybil, WorldCom now had multiple personalities. The long-distance business was a cash cow, milked to build out more fiber. But UUNET, like all Internet service providers, was selling data, not voice traffic. Everyone in Silicon Valley was excited that Internet networks would someday devour voice, making it just another type of data that runs next to e-mail. In other words, one side of WorldCom could one day kill the other side, but until then they got along fine, riding the bull market to new heights.
Complicating Mr. Ebbers’ life was the fact that he wasn’t the only game in town. In 1998 anyone who announced plans to layer fiber could get $1 billion from Wall Street, no questions asked. Dozens of companies strung thousands of miles of fiber. Prices hardly budged, because WorldCom, and everyone else, was enjoying high margins, selling under the regulated umbrellas erected for AT&T and the regional Bells. WorldCom’s ride up was based on the artificial economies created by regulation.
In 1997, charged with investing in these weird markets, I thought long and hard about WorldCom. I liked the concept, but was bothered by all these new players. But then it hit me. Mr. Ebbers was brilliant. He built the new-fangled telecom company first, and would quickly cut prices on bandwidth to the marginal cost of installing new fiber optics. This is straight out of Economics 101: At some lower price, it no longer was profitable for new players to lay fiber, funding would dry up, and WorldCom would own, I mean really own, the market. A few weeks later, I attended a dinner at the Four Seasons restaurant in New York, featuring WorldCom vice chairman (and now CEO) John Sidgmore, hosted by one of the many Wall Street firms salivating over banking fees. I cornered Mr. Sidgmore at the bar before dinner, ready to test my theory. “I figured it out,” I told him breathlessly, drooling my gin and tonic. “You are going to cut the price for bandwidth to the marginal cost of putting in new fiber.” He looked at me like I was from Planet Zorb, and walked away.
Now this happens to me all the time, so I didn’t think anything of it, until he gave his dinner speech. In it, he used his trademark line investors would hear for the next several years. “As far as WorldCom cutting prices, Bill Gates says bandwidth should be free . . . Well, I say software should be free.” Laughter, applause. Forget about marginal anything, they were intent on milking high prices. Within a month, WorldCom bought MCI, and the debt piled up, locking the company into these high prices.
Instead of reshaping the telecommunications world, WorldCom was happy to join the old guard, despite knowing full well the devastating effects of new technology. Mr. Ebbers was enjoying the ride, and the stock kept going up, hitting a split-adjusted $60 in 1999. He was known to wear cowboy boots around the office, and berate investors who asked him questions at analyst meetings.
At one meeting, the guy next to me nudged me and whispered, “Watch this.” He raised his hand and asked, “So what do you intend to do for a wireless strategy?” Mr. Ebbers’s face turned red as he launched into a five-minute tirade on how stupid the cellular business was, and they are all losing money and who needs them. Is that your final answer? A better one would have been “We need a cellular strategy,” since cellular firms were burying long distance into their per-minute rates and 500 minute plans. People began using their cell phones, instead of MCI, to call friends and family.
Mr. Ebbers was too busy with other things. Every time the stock went up, he would raise more debt. WorldCom had around $5 billion in debt at the end of 1996, $20 billion at the end of 1998, and almost $28 billion today. But it never cut prices to stop competitive fiber build-out from Metromedia Fiber, 360 Networks, XO, Global Crossing — today, a bankruptcy lawyer’s dream list.
More Cowboy Boots?
As fiber miles proliferated, prices plummeted. Ah, Economics 101 does work! As WorldCom’s stock began its slide, Mr. Ebbers held on for dear life. When he borrowed money personally (more cowboy boots?), he used his WorldCom stock as collateral. As these loans came due, he was unwilling to sell at “depressed prices” of $10 to $15 (it’s now around $2.50). So WorldCom lent him the money to consolidate his loans, to the tune of $366 million. How a board of directors, representing you and me at the table, allowed this to happen is beyond comprehension. They should resign with Bernie.
Today, prices are probably below the marginal cost to install new fiber. WorldCom denies it’s heading for bankruptcy, but it’s hard to see any alternative. There are too many other bankrupt fiber companies out there already, busy restructuring. For instance, Ted Forstmann is fighting with Carl Icahn for the rights to pump money into XO and McCleodUSA’s resurrection. Out of all this will emerge a large number of debt-free and really nasty competitors that can set their prices to just below the marginal cost of interest payments for WorldCom and Qwest. Their only choice may be to head into bankruptcy to get rid off all that debt. What a strange twist to an old economics lesson.
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