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WorldCom still a good long-term value, analyst says

Despite bumps in the road, telecom still a growth sector

WorldCom chief Bernie Ebbers

CLINTON — Even though the Securities and Exchange Commission has launched an investigation into WorldCom’s accounting practices, its stock price has tumbled, rumors of bankruptcy and layoffs are swirling, and its reputation for slamming continues to be an issue, WorldCom (Nasdaq: WCOM; MCIT), the second-largest long-distance company and the world’s leading carrier of Internet traffic, is still a solid company, say financial analysts.

In the fourth quarter 2001, WorldCom reported revenues of $5.3 billion, reflecting a 7% growth from the fourth quarter of 2000. Its cash earnings, before goodwill amortization, were $595 million. During the quarter, its debt declined by nearly $1 billion to $24.7 billion. Net accounts receivable declined by $277 million, and WorldCom broke even on free cash flow (cash provided by operating activities, less cash used in investing activities).

“The biggest issue right now with any company is concern over having enough cash flow and covering debt payments and debt that we can’t see,” said Nancy L. Anderson, CFP, president of New Perspectives Inc. in Clinton. “As far as we can tell, that’s not the case with WorldCom. They have plenty of cash to cover interest payments many times over. Their claim is that there’s not debt hidden somewhere and that it’s all out there for us to see. At this point, I’m still saying WorldCom’s OK.”

On March 7, the Securities and Exchange Commission launched a confidential probe into WorldCom’s accounting practices, demanding a response within two weeks on a 24-point bill of particulars dating back to January 1999. WorldCom is not alone. In the same time period last year, the SEC initiated only 17 investigations. This year, WorldCom is one of 45 companies being scrutinized by the SEC, on the heels of the Enron-Andersen debacle and the bankruptcy filings in January of Bermuda-based Global Crossing Ltd., a market favorite, and Denver-based Qwest Communications.

“All S&P 500 companies are going to be subject to increased examination by regulatory bodies,” said Stacey Wall, president of Ridgeland-based Pinnacle Trust. “It’s a natural reflex to the Enron debacle.”

From the beginning in 1983 when LDDS, the forerunner to WorldCom, was started, the company distinguished itself with aggressive sales tactics, cost-cutting measures and acquisitions — all inclusive of aggressive accounting practices.

“WorldCom has never hidden its aggressive accounting practices,” said Anderson. “We knew that. As long as we know that, and as long as we can interpret their figures, I don’t have a problem with it.”

Ram Kasargod, managing director and senior analyst for Morgan Keegan, said the entire telecom industry has come under scrutiny, and WorldCom was a target in part because of its affiliation with the troubled accounting giant Arthur Andersen.

“WorldCom was forthright about the inquiry,” he said. “I think the SEC is looking at all carriers that grew rapidly and are making sure they’re above board.”

Among other issues, the SEC is investigating whether WorldCom improperly manipulated its financial reports to make its operations appear stronger than they were. One theory for the SEC probe is that WorldCom’s complex transaction in February 1999 with Plano, Texas-based Electronic Data Systems has come under scrutiny. An SEC spokesperson declined to say whether the SEC was making inquiries about EDS.

“The (SEC) seems to know just what they’re after,” said John P. Gavin, president of SEC Insight, a private research company. “They’re looking into some very precise areas.”

The SEC letter states: “This inquiry…should not be construed as an indication by the commission or its staff that any violation of law has occurred, nor as an adverse reflection on any person, entity or security.”

“I found that sentence quite interesting,” Kasargod said. “It’ll be interesting to see how it plays out.”

Among the SEC-requested items: disputed bills and sales commissions, key merger-related accounting policies and loans the company made to CEO Bernie Ebbers. The sole WorldCom officer with an outstanding loan to the company, Ebbers now owes roughly $375 million for money borrowed to buy WorldCom stock in 2000. He recently told CNBC that he had to meet margin calls when the company’s share price fell and the alternative to loans was selling assets not easily convertible to cash.

“I wasn’t thrilled with the loan (to Ebbers),” said Anderson. “In the overall scheme, it’s a drop in the bucket. The biggest problem is perception because it comes at a time when perception is critical.”

WorldCom had already conducted an internal investigation of nearly $4 million in unauthorized sales commissions by salespeople who used unethical practices, such as routinely double-booking sales, to boost earnings. Those salespeople have since been fired or have resigned.

Prompted perhaps by its acquisition streak, the SEC is asking for all of WorldCom’s documents concerning its accounting for goodwill — an accounting term for the difference of the acquisition purchase price and the assessed value of the acquired company’s assets. Under new accounting rules, a company must write down its goodwill if the value of the acquired company suffers a sustained decline.

“In a changing environment in the telecom market, especially with the slowdown in the economy and the slowdown in the growth of the Internet, some of the goodwill that has accumulated over the years, when expectations for telecom were much higher, obviously needed to be revalued,” said Kasargod. “One of the positives on WorldCom, before the goodwill charge, is that their long-term debt-to-capital ratio was at the low end of the range for the industry. After the charge, it’s about the same as everyone else.”

By the end of September, WorldCom’s goodwill had swelled to $50.8 billion. Even though WorldCom said it would take up to a $20 billion charge to write down its goodwill, the SEC inquiry could result in forcing the company to take a bigger writeoff, creating a cash crunch. Untapped loans require that WorldCom keep its debt-to-capital ratio at 68% or less. Even though it stands at 34% today, a $20 billion writeoff would increase it to 44%. WorldCom would surpass the 68% threshold if its write down exceeds roughly $45 billion.

WorldCom’s slamming reputation might have raised another red flag. Since 1997, WorldCom, which has roughly 20% of the U.S. long-distance market, has had more slamming complaints than AT&T, the No. 1 carrier, which serves about half of all residential customers in the U.S., and No. 3 Sprint.

Last month, WorldCom agreed to pay $8.5 million to settle a California lawsuit filed in July 2000 citing slamming and cramming. In June 2000, WorldCom paid the federal government $3.5 million to settle a slamming investigation by the FCC.

Since then, as part of the agreement, WorldCom has beefed up its anti-slamming tactics which WorldCom spokesperson Claire Hassett calls “the most sweeping in the nation.”

If those woes weren’t enough, the company’s shares, which traded for a high of $64.50 on June 21, 1999, and traded at $10 to $20 for most of last year, tumbled from $12 to $6 in seven sessions on word of the SEC inquiry.

Early last month, WorldCom moved quickly to squash fears that a bankruptcy filing was
imminent and adopted a “poison pill,” or shareholders rights plan, in an effort to stave off possible takeovers.

“The best thing WorldCom has going for it is its size,” said Anderson. “Even though the stock price is attractive, it would take someone very large to gobble them up.”

Kasargod said he didn’t anticipate further industry consolidation until 2003.

“The telecom industry is trading at a discount, and WorldCom is trading at an even bigger discount,” he said. “The industry as a whole is an attractive


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