By Jane Black Disbelief and horror dominated Wall Street on June 26 after No. 2 telecom WorldCom (WCOM) said it hid expenses and inflated cash flow by more than $3.8 billion over five quarters. The bombshell has some experts predicting that the situation could turn out to be one of the worst cases of accounting fraud ever, and it was hard to find an analyst who wasn't predicting WorldCom's demise.
Yet wherever there are losers, someone else is likely to be a winner. And in this case, it could be No. 1 telecom provider, AT&T (see BW, 5/20/02, New Honcho, New AT&T?). Ma Bell President David Dorman wasn't available for comment -- he was in Boston on June 26, opening a data center.
For now, Wall Street, too, seems to think AT&T might benefit the most from WorldCom's troubles. After a tumultuous day that battered telecom stocks across the board, on June 26 AT&T (T) shares ended at $9.62, down just 33 cents (3.3%). Sprint (FON) was down 10.5%, from $11.29 to $10.10. Qwest (Q) got creamed, falling 57.2%, from $4.19 to $1.79.
RAPID DEFECTIONS. How big is the upside? Bernstein Research analyst Jeffrey Halpern says the WorldCom debacle offers AT&T an unprecedented opportunity to win WorldCom's disgruntled customers. This group -- primarily large businesses -- has already seen the negative and expensive fallout of one telecom bankruptcy, that of Europe's KPNQwest, in the past few months. So they're unlikely to sit idly by again while one of the largest telecoms struggles for survival. Indeed, Halpern expects WorldCom customer defections to be rapid.
The result could be a cumulative $3 billion increase in revenue over the next four years for AT&T's Business Services unit, which caters to corporate customers and is expected to have $26 billion in revenue this year. Halpern also believe AT&T Business Services could end up having higher margins on earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2005 than originally anticipated.
Although margins continue to slip year-over-year as competition increases, Halpern thinks AT&T Business Services could end up with EBITDA margins of 24.3% in four years rather than the 23.4% he was estimating before the WorldCom news broke. In an industry beset by shrinking margins, a margin increase of one percentage point would be stunning.
BITTERSWEET WIN. Telecom specialists agree that because of its scale, AT&T could be the primary beneficiary of the $8 billion in U.S. data-services business, though European provider Equant (ENT) could pick up some of WorldCom's $3 billion in international business, while Sprint and even Qwest, which itself is under investigation by the Securities & Exchange Commission for aggressive accounting practices, fight for the scraps.
Still, any AT&T victory would be bittersweet. News of WorldCom's accounting fraud is hurting all the players in the already damaged telecom sector. Shell-shocked investors may continue to flee for fear that the fraud at WorldCom isn't limited to one company's misallocation of cash and capital expense. Doomsayers warn that the news could spark revelations at other telecoms, where executives might have been tempted to boost profits to prop up tumbling share prices.
So far, though, no evidence indicates that other telecoms fraudulently boosted cash flow. WorldCom didn't return repeated calls for comment. But if it's forced to file for Chapter 11, which looks probable, many of its top clients will likely have to switch to other providers. Government agencies, for example, are forbidden from doing business with insolvent companies.
HEDGED SUPPORT. WorldCom now provides voice, data, Internet, and video-conferencing services to more than 60 federal agencies under the FTS 2001 contract, including the Social Security Administration, Transportation Dept., and Defense Dept. Other government clients include the California Integrated Information Network, a consortium of all publicly supported agencies and municipalities in California. When that contract was signed in December, 1998, it was the largest outsourced state telecom deal in history.
Large corporations are keeping their options open. WorldCom provides data and Internet services as well as managed accounts for insurance company AFLAC's 37,000 sales agents. AFLAC told BusinessWeek Online that "as long as we continue to receive service that meets our needs and expectations, we will continue our relationship. We have no reason to anticipate any disruption in service, but we would be able to obtain the necessary services from other telecommunications providers if necessary." While the statement indirectly supports WorldCom, AFLAC's is hedging in the event that Worldcom's problems deepen.
Understandably, government and business customers want assurances that their crucial communications are safe and that carriers have the cash to provide new services and customer support, says Marty Hyman, a senior telecom partner at Booz Allen Hamilton. He points out that WorldCom's announcement that it will slash 17,000 workers, a fifth of its workforce, and cut capital expenditures to $2.1 billion may send just the opposite signal.
STILL HOPE.And corporate business is the only bright spot on the telecom horizon. In 2002, WorldCom Group, which serves enterprise customers, was expected to generate $20 billion based on annualized first-quarter revenues. Even at a restated 26% margin, which includes the newly stated expenses, vs. previous claims of 34%, that would mean $5.2 billion in EBITDA earnings -- hardly a number to sneeze at. And those customers will need to get their telecom needs met by somebody if not WorldCom.
Still, government and corporate customers don't make quick or dramatic changes when it comes to data services. Big businesses have complex network architectures supporting mission-critical applications that can't be moved with the flick of a switch. Moreover, many corporations now have carrier network components on site or locate their own servers in carrier data centers. Rich Nespola, CEO of telecom consultancy TMNG, says it can takes from 30 to 120 days to physically migrate complex networks from one carrier to another.
At least one analyst thinks that offers some hope for WorldCom. "Over time, it may lose business. But I think there's an unbelievable amount of inertia," says Susan Kalla, a usually bearish telecom analyst with investment firm Friedman, Billings & Ramsey in Arlington, Va. "Even Global Crossing kept customers to the bitter end."
As the WorldCom scandal unfolds, corporate chief information officers and telecom analysts across the country are white-knuckling it. Can you say "volatile"? What's clear is that WorldCom owns a powerful data network and thousands of customers that could bring huge cash flow, even profits, to aggressive competitors. It's far too early to know what WorldCom's fate will be. But if it can't be saved, AT&T just might pick up its pieces. Black covers technology for BusinessWeek Online in New York