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Can MCI Hold The Line?


When it emerged from bankruptcy in April, MCI Inc. (MCIAV) had the makings of a fearsome competitor. The long-distance carrier was virtually free from its crippling $41 billion debt. It no longer lugged around the scandal-splattered name of WorldCom. In Michael D. Capellas, the former Compaq Computer Corp. (HPQ) CEO, it had an energetic leader who could hawk MCI service to legions of business customers. Perhaps most important, MCI boasted rich assets. Its crown jewel: the biggest swath of the global Internet backbone.

Scant months into MCI's new life, the company's rivals are hardly quivering. The Asburn (Va.) company racked up a $388 million first-quarter loss and faces declining revenues in most lines of business. Worse, MCI stands to suffer from the Bush Administration's June decision not to aid the long-distance carriers in their efforts to break into the Bells' residential market. It's a setback the company could withstand if its Internet businesses were prospering as expected.

But they're not. MCI's sales of Internet access to businesses -- the company's core customer base -- fell a steep 27.8% in the first quarter, to $465 million, while archrival AT&T's (T) Internet revenues rose 5.9% in the same period, to $471 million. Overall, MCI's business Internet sales, which account for about 13% of total revenues, are expected to decline 18% this year, to $1.8 billion, while overall revenue contracts by 14%, to $21 billion, according to analyst Patrick Comack of Guzman & Co. in Miami.

Capellas, who was unavailable for comment, must now race to save MCI as an independent company. MCI's stock has dropped to just under $14, from a post-bankruptcy high of $19.75. Its market cap is a paltry $4.4 billion. And it ranked last in a customer-satisfaction survey of its voice and Internet customers released by the Yankee Group in early June.

Potential acquirers such as BellSouth (BLS), Verizon Communications (VZ), and SBC Communications (SBC) are circling, though Bell execs say no deal is imminent. To resurrect MCI, analysts say, Capellas needs to stitch together new offerings on the run, such as Internet phone service and videoconferencing. But he'll have lots of company. "Everybody is doing Internet convergence," says analyst John Hodulik of UBS Securities (UBS). "It's not a way to [solve] their problems."

How did things get so dire? For starters, MCI's grip on the Internet, while strong, was far from exclusive. A glut of fiber capacity in that market has sent rates plunging from a median $110 a month last year for a standard business Internet connection to $60 a month, according to telecom consultant TeleGeography Research Group. At the same time, while MCI ruled much of the dial-up Internet market, the mass migration to broadband, extending to 33% of U.S. households, saps the company's hold. Given that trend, says Jonathan C. Crane, MCI's chief strategist, "you shouldn't be surprised our Internet business is declining."

RAINY-DAY FUND

Capellas' strategy is to scramble into richer Internet businesses before all of the competition arrives. In April, 2003, MCI launched its most promising product, a voice-over-Internet phone service for businesses dubbed MCI Advantage. The product puts MCI ahead of AT&T, which so far has only a consumer Internet phone offering. But Advantage may not attract a wide customer base till next year, says Eric Paulak, an analyst at Gartner Inc.

Capellas still has cash, $4.8 billion at last count, to tough it out at least a year. He's saving by holding down capital spending. Analysts estimate that the $880 million MCI will spend this year barely reaches one-third of AT&T's total. While MCI contends that it spent $40 billion during the boom to upgrade its network, new constraints on capital spending bode ill for the future.

For now, Capellas will be sweet-talking customers and investors, working to convince them that MCI's tarnished Internet jewel will eventually shine. A tough sell? Even MCI's potential predators must be reevaluating.

By Catherine Yang in Washington and Brian Grow in Atlanta


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