WorldComlate Tuesday that it had improperly accounted for almost $4 billion, puffing up its financial results for the last five quarters. The revelation rattled the telecommunications sector as many analysts noted that the company will have a tough time surviving.
Also on Wednesday, the U.S. Justice Department said it is reviewing the case. "The matter is under review," said Bryan Sierra, a spokesman for the Justice Department's criminal division. He declined any further comment.
The DOJ already is investigating last year's collapse of energy giant Enron.
WorldCom shares were halted after falling to a low of 9 cents in premarket trading. Shares closed Tuesday at 83 cents. Qwest Communications International and other telecommunications shares fell Wednesday, with Qwest losing $2.40, or 57 percent, to close at $1.79.
The broader markets were rattled in earlier trading, but they recovered by market close. The Dow Jones industrial average was off 6.71 points to 9,120.11, and the Nasdaq gained 5.34 points to 1,429.33.
"WorldCom becomes telecom's Enron," said RBC Capital analyst John Wilson, connecting two companies tied by accounting scandals and a beleaguered auditor, Arthur Andersen.
WorldCom's accounting problems arein the telecommunications sector where companies like Qwest are under the microscope of the Securities and Exchange Commission. But unlike some of the more recent hits to the corporate world, the demise of WorldCom could have big implications for the tech sector and business in general, analysts said.
Meta Group says many user organizations are panicking about WorldCom's situation,
fearing that services might stop immediately. Meta Group believes the
WorldCom network will keep operating, even if there is a near-term
"There are clearly wider implications of WorldCom's announcement," said Robert Fagin, an analyst at Bear Stearns. "Telecom industry health is apparently even weaker than previously thought. Additionally, WorldCom's predicament could cause disruptions for many businesses across the U.S."
According to WorldCom, UUNet's IP network spans 3,800 points of presence and incorporates more than 2 million modem ports.
The future of WorldCom's key assets largely depends on whether the company can convince its banks to extend credit to the company when its financial results--the same ones used to justify the company's high-flying share price in recent years--are in question. Meanwhile, 17,000 impending layoffs at WorldCom could hurt the quality of service.
The company said its senior management was "shocked" by the accounting problems. The disclosure cost WorldCom's chief financial officer, Scott Sullivan, his job.
John Hodulik, an analyst at UBS Warburg, said that WorldCom, straining with about $30 billion in debt, may not be able to use its $5.35 billion in available credit funds if it hasn't used that money already. "The banks may try to force repayment of $2.65 billion that was already drawn, which, we believe, would force WorldCom into bankruptcy," he said in a research note.
WorldCom said that it will restate its results and that its cash position won't be affected, but analysts said the biggest issue is whether customers will defect.
"Intense media focus will make it extremely difficult to attract new customers or retain existing customers," Hodulik said. A customer exodus would accelerate the company's cash crunch, he added.
Winners and losers
Analysts said it's likely that WorldCom customers will move to rivals that are deemed safer bets such as AT&T and Sprint. Long-distance and Internet customers will probably pull back given WorldCom's financial problems, and contracts up for renegotiation are likely to be lost, analysts said.
Cable & Wireless, which primarily competes with WorldCom's UUNet unit, is also aggressively targeting the struggling company's enterprise customers. "We're definitely looking to take a few," a Cable & Wireless representative said.
Cable & Wireless plans to convince WorldCom customers that it is more stable. The company, which acquired Exodus Communications in February, carries no net debt and has $3.8 billion in cash, the representative said.
In the long run, the WorldCom woes could signal consolidation across the board in the telecommunications sector.
Analysts said WorldCom's problems could hurt the telecommunications sector as a whole, similar to how energy companies saw their stock prices dwindle following accounting and other problems at Enron. "For any telecom company with credibility issues, the burden of proof just got higher," said Merrill Lynch analyst Adam Quinton.
In a report, J.P. Morgan analyst Marc Grossman laid out some possibilities if WorldCom is forced into Chapter 11 bankruptcy proceedings. In the short term, Grossman predicts, WorldCom's enterprise and government customers will look toward "secure alternatives" such as AT&T and Sprint.
After Andersen, accounting worries stick
The bookkeeping questions raised
threaten to drag down tech companies.
And Baby Bells are likely to be initial losers in the WorldCom shakeout. Those telephone companies are likely to have write-downs because they count WorldCom as a customer of dedicated and switched access services. Morgan Stanley estimates that WorldCom accounts for about 4 percent of Baby Bells' revenue.
Nevertheless, Grossman said that WorldCom may make an attractive acquisition candidate for a Baby Bell looking to offer long-distance service to corporate clients. If such a combination occurred, it would "prompt further industry consolidation."
If WorldCom were to pair up with a Baby Bell such as Verizon Communications or SBC Communications, it would pose a big threat to AT&T, Grossman said. A combination like that will not happen overnight, he said. If WorldCom emerged from a bankruptcy restructuring with a clean balance sheet, it would likely be able to cut long-distance rates, triggering more consolidation.
"We view the WorldCom news as possibly the beginning of an endgame process, which results in an industry shakeout followed by a more rational industry, comprised of a few vertically integrated players," he said.
Bad to worse
WorldCom's fortunes began to unravel on Monday following a report from Salomon Smith Barney analyst Jack Grubman.
Grubman's report, which was issued late Friday, knocked WorldCom shares below $1, raising worries of a possible bankruptcy and the possibility of a Nasdaq delisting.
In his report, Grubman lowered his rating to "underperform" from "neutral" and said the company would have to raise more cash because capital spending has shown no signs of picking up. That report led to worries that WorldCom could be facing customer defections.
Grubman's report had a big effect, considering that the analyst has been sharply criticized for being upbeat about WorldCom, Global Crossing and other telecommunications companies even when their fortunes clearly took a turn for the worse.
Grubman was also known for having an inside track at the companies he covered due to Salomon's investment banking relationships.
Citing credit worries and the fact that Moody's and Standard & Poor's recently cut WorldCom's debt rating, Grubman said, "We are hard pressed to get more than a $1 equity value."
Although investors were clearly voting on WorldCom's future with their feet, analysts said there are a lot of remaining questions.
Notably, WorldCom has to outline its guidance for the rest of the year in light of its recent accounting disclosure. It's also unclear whether WorldCom's restructuring plans "will ultimately be too little too late," Merrill Lynch's Quinton said.
The company also has to convince Nasdaq to keep it listed on its exchange. If WorldCom trades below $1 for 30 consecutive days, the Nasdaq may choose to delist shares. A delisting would also mean that WorldCom shares would be less liquid, a problem considering the company may have to issue stock for more funding.
In other words, analysts are telling their clients to stay tuned. "WorldCom's disclosures leave a laundry list of questions unanswered," Bear Stearns' Fagin said.