WorldCom's Hidden Losses May Force Bankruptcy Filing

Bloomberg.com | June 26, 2002 | Tom Giles

[HAL9000]

Clinton, Mississippi, June 26 (Bloomberg) -- WorldCom Inc.'s disclosure that it concealed losses for more than a year may force the company to file for bankruptcy, surpassing Enron Corp.'s collapse as the largest in U.S. history, investors say.

The No. 2 U.S. long-distance telephone company yesterday said it hid $3.9 billion in costs, giving fresh ammunition to a Securities and Exchange Commission accounting probe and spurring the Justice Department to consider a criminal inquiry. WorldCom borrowed $30 billion during a 1990s buying binge and is having trouble repaying debt as demand slumps.

WorldCom will cut 17,000 jobs to conserve cash as the odds shrink it will persuade banks to grant a $5 billion loan to replace a smaller one used up last month. The company's disclosure coursed through world markets, causing shares of suppliers and lenders to plummet, and shaking investor confidence in corporate reporting.

``The American equity market has taken on the flavor of a casino to many investors,'' said Timothy O'Brien, who manages $265 million in the Evergreen Utility and Telecommunications Fund. ``The cleanup process is not going to be pretty. This is already the ugliest I can remember.'' The fund has no WorldCom shares.

President George W. Bush said the U.S. will ``go after'' executives who mislead investors, and he called WorldCom's accounting practices ``outrageous.'' Senate Majority Leader Tom Daschle said he would push legislation to create an accounting oversight board, while Representative Billy Tauzin said the House energy and commerce committee he heads will open an investigation.

Investor Losses

WorldCom bond investors lost more than $7.3 billion overnight. The company's notes and bonds plummeted to as little as 14 cents on the dollar from as much as 78 cents. Those bonds had a face amount of $28 billion and are now worth about $4.2 billion.

WorldCom stock was halted for the entire day on the Nasdaq Stock Market. The stock reached $62 in June 1999 and has lost 94 percent of its value this year. The shares closed yesterday at 83 cents.

The prospect of a WorldCom collapse dragged down shares telephone-equipment suppliers. Lucent Technologies Inc. fell 37 cents to $1.60, Nortel Networks Corp. declined 27 cents to $1.33, and Juniper Networks Inc. fell $1.34 to $4.95.

Internet services providers that use WorldCom sought alternatives. Ryan Troy, chief executive of Steamboat Springs, Colorado-based Screaming Internet Inc., with 12,000 residential and business Internet customers said his company would turn to rival Broadwing Inc. for service.

A bankruptcy filing by WorldCom, with assets of almost $92 billion as of March, would top Enron, the energy trader that failed last year. Adelphia Communications Corp. filed for protection from creditors yesterday, and the bankruptcies of Enron and Global Crossing Ltd. amid accounting investigations already had undermined faith in financial markets.

AT&T Corp. is the largest U.S. long-distance company.

`Forced to File'

``It looks like they will be forced to file for Chapter 11,'' said Jim Shallcross, who helps manage $5.5 billion of bonds at Independence Fixed Income Associates in McLean, Virginia. The firm sold all of its WorldCom bonds about two months ago, he said.

Standard & Poor's lowered its rating on WorldCom's junk-bond debt five levels to ``CCC minus'' from ``B plus.''

``The downgrade is based on the high degree of uncertainty surrounding WorldCom's ability to ultimately pay its outstanding debt,'' S&P analyst Rosemarie Kalinowski wrote. ``Furthermore, the restatement and the expansion of the SEC investigation could adversely impact the current bank negotiations and the company's ability to retain customers.''

Brad Burns, a WorldCom spokesman, said: ``We met with bankers yesterday and will continue talks with them.''

Banks are allowed to block WorldCom from drawing more funds because the company defaulted on its agreements by fabricating profits, according to the terms of the credit lines arranged by lenders including J.P. Morgan and Bank of America.

The company said it fired Chief Financial Officer Scott Sullivan and had hired former SEC enforcement chief William McLucas to head an internal investigation.

The company's $11.9 billion bond sale last year was the biggest ever by a U.S. company. Citigroup Inc.'s Salomon Smith Barney unit and J.P. Morgan Chase & Co. managed the sale. Both banks also have arranged loans to the company. Neither would comment on how much money it is owed.

Salomon advised WorldCom on many of its acquisitions, including the $44 billion purchase of MCI Communications Corp. in 1998, and a failed bid for Sprint Corp. in 2000.

The firm's U.S. telecommunications analyst Jack Grubman, who is being sued for allegedly misleading investors about WorldCom stock, cut his rating on the company to ``underperform'' Monday, saying that WorldCom may not get the credit access that it needs.

A Day Before

Grubman, who maintained a ``buy'' rating on WorldCom from 1997 through April of this year, only has issued one other ``underperform'' rating, on Winstar Communications Inc., a day before the company filed for bankruptcy protection.

With a ``buy'' rating from Grubman, WorldCom became one of the highest fliers in the 1990s stock market boom. The company was founded based on a business plan hatched in a Mississippi diner in 1983. At one point, WorldCom had a market value of more than $150 billion.

Since 1988, executives and directors including Bernie Ebbers, ousted as chief executive in April, made about $1.5 billion by selling WorldCom shares, according to the Washington Service.

Loans to Ebbers

The SEC's probe includes reviewing loans totaling $408.2 million as of May to Ebbers, the company said in an SEC filing.

``The WorldCom disclosures confirm that accounting improprieties of unprecedented magnitude have been committed in the public markets,'' the SEC said in an e-mailed statement.

The Justice Department said it is looking into opening a criminal investigation into the company's accounting practices.

Arthur Andersen LLP, WorldCom's auditor at the time, said it wasn't aware of any breach in accounting rules. Arthur Andersen was WorldCom's auditor until May, when the accounting firm was replaced by KPMG LLP, the U.S. affiliate of KPMG International, according to a proxy filing with the SEC.

The company's CFO, Sullivan, joined WorldCom in 1992, with the purchase of Advanced Telecommunications Corp. Ebbers credited Sullivan with developing the plan in 1997 to outbid British Telecommunications Plc for MCI Communications Corp.

WorldCom said the internal audit discovered that expenses that should have been recorded on its income statement were instead booked as capital expenditures. That overstates earnings because capital expenses are recorded over time, rather than at the time the costs are incurred, accountants said.

``Costs that should have been expensed were charged as capital expenses, which increased their earnings,'' said Michael Sutton, a former chief accountant at the SEC.

Without the transfers, WorldCom would have reported a net loss for 2001 and the first quarter of 2002, the statement said. Sullivan couldn't be reached.

WorldCom said in March that the SEC had requested information on its accounting and the loans to Ebbers, who is 60 years old.

Andersen said in a statement that its work with WorldCom complied with SEC standards ``at all times.''

WorldCom's CFO ``withheld'' information about line costs, said Andersen, which was found guilty this month of trying to impede an SEC inquiry into Enron.

[habs4ever]

Still no details of exactly what these expenses were.I'd think the IRS would feel a little cheated right now ;-)

[TheCPA]

IF they treated costs as capital expenditures on their tax return rather than as current expenses, the company would have paid too much tax, rather than too little. However, we do not know if they treated the costs the same way on the tax return as they did on their financial accounting books.

[SauronOfMordor]

IF they treated costs as capital expenditures on their tax return rather than as current expenses, the company would have paid too much tax, rather than too little.

Only if they had net profit to tax

[Donald Stone]

It is suspected that GE is going into maximum damage control as we speak !!!!!!!!!!

[southernnorthcarolina]

...the odds shrink it will persuade banks to grant a $5 billion loan to replace a smaller one used up last month.

Ya think?

[habs4ever]

I don't follow you there.By capitalizing costs vs expensing them, their gross was higher than it should have been, correct? They inflated cash flow by higher depreciation, but shouldn't their earnings been a lot lower than they were, and thus their tax bill??

[habs4ever]

Ahhhhhhh.....yes, the taxes were overpaid.Silly me.

[Donald Stone]

Could somebody explain to me in layman terms what these bond markets are and who would the investors in these bonds be, major banks, institutions, or the general public ????

WorldCom bond investors lost more than $7.3 billion overnight. The company's notes and bonds plummeted to as little as 14 cents on the dollar from as much as 78 cents. Those bonds had a face amount of $28 billion and are now worth about $4.2 billion.

[lelio]

What about the other companies in the telecom sector whose numbers were probably made up to be just like WCOM's growth? Makes me wonder if those companies also fiddled the books to make it look like they were in step with them.

[norraad]

More just telecom companies are playing this modern shell game.

[habs4ever]

It's corporate debt with a coupon and maturity, and it trades like stocks between dealers and is bought by any type of investor.It is Graded by a ratings agency like Moody's and S&P for safety, etc and quality.

This paper now will got into the dogpatch know as distressed securities and be part of the community know as "workouts".Prime hunting ground of vultures and arbitrageurs, and lawyers:-)

[TheCPA]

It depends. Even if they had a loss on the tax return, a company may carry back a net operating loss (NOL) for two years.

[TheCPA]

I said that if they treated costs as capital expenditures on their tax return rather than as current expenses, they would have paid too much tax. They would have paid too much tax because their reported taxable income would have been too high. They might be entitled to a refund on an amended return if they paid tax and treated costs that are deductible as ordinary and necessary expenses as costs chargeable to a capital account.

[parsifal]

Are WorldCom and MCI the same? I can't stand MCI, so if they are, good riddance. parsy.

[habs4ever]

A question for you here: If this is a restatement of capitalized costs going back 6 quarters, then it appears the company was in a liquidity death spiral beginning then if they couldn't take cash charges.Correct??

They may have had a year and a half to get a restructuring plan in place yet sat on it, hoping the operations would generate cash.What did the board know and when did they know it??The market sure knew it was a dog.

[TheCPA]

A bond is a security that is usually sold in face amounts of $1,000 each. It is really just a fancy promisorry note. Investors who buy bonds are loaning money to a company in exchange for interest payments and the expectation that the principal will be repaid at maturity. Interest is usually paid twice a year. Bonds trade in the marketplace similar to the way stocks trade. Bonds prices react inversely to market interest rates. Bond prices are also affected by the creditworthiness of the company that owes the money on the bonds and the time to maturity.

[habs4ever]

Thanks for the article.

Nice homepage :-)

[TheCPA]

Whether a cost is capitalized (treated as an asset) or treated as an expense, has no direct effect on liquidity. The cash has gone out or the company has incurred debt to pay for the cost in either case. However, if the company failed to deduct expenses on the tax return and treated them as capitalized costs, the company would have paid too much tax. That would hurt liquidity. Also, if the cost was an expense it might have caused the company to violate debt covenants and impair its ability to borrow or result in loans being called. They might have misclassified the cost to avoid those consequences. The line between capitalizing costs and expensing them is not always clear. For example, if a business incurs a cost to fix a hole in the roof, that is an expense. If the business replaces a roof, that is a capitalized cost. If the business repairs a major part of the roof to fix leaks, the treatment is not so clear. However, in financial accounting and auditing, accountants are supposed to treat gray areas conservatively.