Worldcom-Mci Case Analysis - Worldcom-Mci

Worldcom-Mci

Case Analysis - WORLDCOM-MCI

The age of the internet - the age of the multinational corporations - the age of record high profits and bankruptcies

The modern global context is filled with examples of greed, deceit and manipulation. And more sadly, these affect the business communities, the organizations we trust to provide our commodities, services, jobs or the organizations in which we invest our life savings. One may tend to believe they have witnessed all these in the case of Enron's fraud and bankruptcy, but it may not be entirely true. While Enron was indeed one of the largest bankruptcies of the twenty-first century, it was only the second - the largest was that of telecommunication's giant WorldCom.

Founded in 1983 as a regional company, WorldCom achieved impressive successes and became able to compete with at&T. The primary strategy at the basis of their growth has been the acquisition of various organizations activating within the same industry. Today however, founder Bernard Ebbers is serving a 25 years sentence and what is left of the organization, has lost most of its identify and has itself been purchased by a telecommunications operator.

The following lines attempt to shed some light into the events that occurred throughout the company's 25 years of existence, with emphasis on their fraud and bankruptcy, to culminate with the quiet present.

2. WorldCom

The foundation name of WorldCom had initially been LDDS, or Long Distance Discount Services Inc. And it was established in 1983 in Mississippi. The selected CEO was Bernard Ebbers. LDDS commenced as a small organization, offering communication services to regional customers. Their tremendous growth was mostly due to the strategic mergers and acquisitions of several smaller companies, such as the merger with Advantage Companies Inc. In 1989, Metromedia Communications Corp. In 1993, IDB Communications Group Inc. In 1994 or the MFS Communications Company in 1996 (Cooper, 2008).

As time went by, the company continued to merger with other organizations, the most important process being the acquisition of MCI in 1998. The deal was signed for $37 billion and the newly formed organization was named MCI WorldCom. In June 1999, the WorldCom stock was being traded at a value of $64, making Bernard Ebbers a billionaire and WorldCom the "darling of the New economy" (Moberg and Romar, 2002). By 2001, they had become the largest provider of internet services across the United States and the second largest company offering long distance communication services.

3. Commencement and Causes of Problems

The situation created at WorldCom has been debated for several years now and all the information have yet to be put in place. Whereas the bankruptcy audit revealed some of the causes, the post-bankruptcy audit revealed another take on the matter. As more and more former and current employees come front to share their experiences, it is quite possible that new pieces of information will arise.

A study conducted immediately after the commencement of the bankruptcy procedures by the Markkula Center for Applied Ethics revealed three primary causes, all reflecting poor ethical behaviors. They refer to:

The growth strategy based on mergers and acquisitions

The granting of loans to senior officers, and the lack of a strong hand to lead the organization

Most of WorldCom's growth is based on an aggressive strategy of corporate acquisitions, namely 65 of its most fruitful purchases. But despite the expected benefits, the newly acquired firms failed to meet the financial objectives that had been set. Between 1991 and 1997 for instance, WorldCom had spent an estimated $60 billion for purchasing other companies, but the results of these operations had materialized in a $41 billion debt (Romero and Atlas, 2002). This is most likely due to the challenges encountered in integrating the newly acquired companies. Seeing that WorldCom had been the combination of 65 companies, the management failed to organize all components into a single unified unit, in which companies and people could work together and increase the shareholder and customer value.

Also, a most important challenge was that of properly implementing the generally accepted accounting practices (GAAP). Seeing that the 65 companies brought a baggage of financial statements, account receivables and debts, the accounting team at WorldCom failed to address these accounting problems. In addition, their approach to financial statements was a liberal one, meaning that they took the liberty to make profits seem bigger than they were in reality. For instance, the WorldCom accountants would register within a quarter the millions in acquired assets, and simultaneously, they also "included in this charge against earnings the cost of company expenses expected in the future. The result was bigger losses in the current quarter but smaller ones in future quarters, so that its profit picture would seem to be improving" (Eichenwald, 2002).

Another problem which should have captured the attention of the WorldCom management was the handling of the account receivables. The company did not implement an official direction in this instance and they simply chose to ignore the customers that were not paying their debts to the organization. This generated negative impacts as the management was unaware of the extent of the customer debts and foremost, without the proper information, it neglected to constitute adequate provisions. Foremost, since they did not know about the account receivables and did not constitute provisions, they were able to report higher profits than the real ones (Sender, 2002).

The process of granting senior executives corporate loans has also revealed poor ethical norms and contributed to the WorldCom bankruptcy. When the stock price began to decrease, Ebbers requested a corporate loan to pay for his margin calls. As his collateral was insufficient, the board granted him a record high $341 million loan. The strategy would have been a useful one had the stock increased, but this did not happen. Similar benefits were offered to other executives, such as CFO Scott Sullivan or the accountants at Arthur Andersen, the audit organization employed by WorldCom at that stage.

And these services were bilateral as both CEO and CFO received significant incentives and rewards from Jack Grubman, telecommunication analyst at Salomon Smith Barney. The services were offered as rewards for the inside information received from Sullivan and Ebbers, based on which Grubman could make suggestions to buy or purchase the WorldCom stocks. However, most of the information offered to the analyst was manipulated and aimed to increase the sale and price of the corporate stock. At these times, the conflicts of interest and the breaking of the ethical rules was loosely regarded by the players as a synergy. By March 2002 however, the WorldCom stock had fallen by 90% and Jack Grubman wrote a mea cupla letter to the misinformed investors (Moberg and Romar, 2002).

4. The Scandal

February 2002 was a turbulent month for WorldCom CEO Bernard Ebbers, who saw himself forced to resign, after the financial problems were revealed to the board by Cynthia Cooper. The internal auditor pointed out various misleading entries in financial statements, which were aimed to conceal a misallocation of nearly $4 billion in corporate expenses and as such misguide the investors.

The first signs of a problem within WorldCom were made public in late June, 2002, when the company officials recognized a problem in improperly accounting more than $3.8 billion of company expenses. On a Sunday July, the company failed for bankruptcy procedures, but they still maintained their optimism. For instance, Michael K. Powell, the chairman of the Federal Communications Commissions stated: "I want to assure the public that we do not believe this bankruptcy filing will lead to an immediate disruption of service to consumers" (Romero and Atlas, 2002). Foremost, since the bankruptcy would spear the company from $2 billion payments in interest rates, they hoped of benefiting from additional financial resources in the future. The declared bankruptcy did not impact the WorldCom subsidies in Mexico and Brazil.

The officials at WorldCom also ensured their customers that the organization would continue to operate and foremost, they had already received financing promises from banking institutions. Their future ventures revolved around a process of corporate restructure and reorganization, from which they hoped to emerge as a stronger company, said John Sidgmore, chief executive of WorldCom, quoted in a New York Times article by Simon Romero and Riva Atlas.

The month following these statements however, more financial mistakes were revealed and CFO Scott Sullivan was fired. Financial controller David Myers resigned. SEC (Securities and Exchange Commission) failed fraud accusations against WorldCom and the Department of Justice commenced their investigation. The most important players in the fraud, Bernard Ebbers and Scot Sullivan believed that their quick replacement with integrant employees would help redeem the affected image of WorldCom. Therefore, an audit was to be conducted under the supervision of Nicholas deB. Katzenbach and Dennis R. Beresford - the two new members of the WorldCom board.

Even before the bankruptcy had officially been declared, WorldCom's stakeholders tried to limit their losses by preventing the organizations' further access to resources. A court decision in this instance ruled in favor of minor restrictions on cash usage. The first three organizations in line to recuperate their funds were Citigroup, J.P. Morgan and General Electric Group. They had been offering financial solutions and encouragement to purchase the WorldCom stock based on a favorable business relationship. However, at the time when bankruptcy procedures were commenced, the three organizations recognized their losses and intended to recuperate them.

A succinct presentation of the period surrounding the crisis could be reveled by the media stories:

27 June 2002 - information on the people affected by the WorldCom crisis become available - about 60 banks across the globe had granted loans to the organization or purchase bonds

27 June 2002 - SEC charges the organization with fraud and three organizational leaders are subpoenaed before a governmental committee

28 June 2002 - John Sidgmore announced a cut in costs by $1 billion and the downsize on 17,000 employees

U.S. President George Bush condemns organizational fraud and asks for tougher new laws in this matter

July 2002 - WorldCom announces that the questions raised relative to the ethics of their operations would be answered through a strict audit analyzing deals and documents dating back from 1999

July 2002 - Bernard Ebbers and Scott Sullivan appear before the American congressman, but refuse to testify, based on the fifth amendment of having the right not to incriminate themselves (BBC News, 2001)

21 July 2002 - the company files for bankruptcy and announces a $41 billion debt

August 2002 - the audit committee finds another $3.3 billion irregularity, forcing the company to restate their earnings

March 2004 - former CEO pleads not guilty on the accounts of fraud and conspiracy

May 2004 - Bernard Ebbers is found guilty of falsifying financial statements sent to the Securities and Exchange Commission

15 March 2005 - Ebbers is found guilty of fraud, conspiracy and falsification and faces a sentence up to 85 years

13 July 2005 - Ebbers receives a 25 years sentence

26 September 2006 - as the appeals filed fail to change the initial sentence, Bernard Ebbers is incarcerated (CBC, 2008).

As the company went into bankruptcy, an audit was conducted. The post-bankruptcy audit revealed two more important pieces of information. First of all, WorldCom had overvalued numerous acquisitions by $5.8 billion and secondly, it had estimated a pre-tax profit of 7.6 billion for 2000. "In reality, WorldCom lost "$48.9 billion (including a $47 billion write-down of impaired assets)." Consequently, instead of a $10 billion profit for the years 2000 and 2001, WorldCom had a combined loss for the years 2000 through 2002 (the year it declared bankruptcy) of $73.7 billion. If the $5.8 billion of overvalued assets is added to this figure, the total fraud at WorldCom amounted to a staggering $79.5 billion" (Romar and Calkins, 2006).

The fraud has also been backed by another player, Tom Stukla, a capacity planner at WorldCom. In his operations, he used an Excel spreadsheet to estimate the expected growth in revenues, due to the growth of the internet traffic. Current data indicate however that his estimates had been wrongful, as he suggested that internet traffic doubles every 100 days - an unsustainable and unrealistic scenario. Foremost, in his planning processes, he failed to correlate the reality of the facts, and simply used variables and parameters as he saw fit (Faber, 2003).

5. Consequences and Remedy

WorldCom filed for Chapter 11 Bankruptcy protection in 2002 and regained from it by 2004. As this happened, the organization officials saw the impending need of changing their name. This strategy was aimed to salvage what was left of the corporation's image and reputation. Today, the company is simply called MCI Inc. And is being traded on NASDAQ under the symbol MCIP, as compared to WCOM, its pre-bankruptcy symbol.

The following CEO and CFO, Michael Capellas (former CEO of Compaq Computer) and Robert Blakely fought a long battle to conduct a through audit analysis of the organization, settle the debt, reorganize MCI and set a new direction for development. The operations implied the efforts of approximately 1,500 individuals. "At the peak of the audit, in late 2003, WorldCom had about 1,500 people working on the restatement, under the combined management of Blakely and five controllers [...] the total cost to complete it: a mind-blowing $365 million" (McCafferty, 2004).