COMPETITON AND TECHNICAL CHANGE IN TELECOMMUNICATIONS:
SOME LESSONS FROM WORLDCOM
José Rogerio Vargens Filho1
1. Introduction
The telecommunications industry has been changing rapidly in the last two decades.
Technological change, institutional reorganization, and globalization are the most important
factors that have transformed and intensified competition in the industry. However, competition
does not increased symmetrically in every telecom segments. It increased faster in the long
distance telephone segment than in the local one. New services were developed, specially those
related to the Internet, but some of this services did not provided the return that telecom
companies expected they could do. The case of WorldCom brings some lessons about how
technology and competition changed in telecommunications, since the company strongly suffered
the impacts of the long distance consumer segment and virtual business slowdown.
At the beginning of the 1990’s, WorldCom was an unknown telecom long distance carrier from
Mississippi. In few years, the company experienced a fast growth based on aggressive
acquisitions and financial trends. In 1997, WorldCom took over MCI Communications with the
highest value corporate bid in US history, producing the greatest merger in telecommunications
history: MCI WorldCom. The new company emerged from the fusion as the No. 2 overall
telecom operator in the world, behind AT&T, and the No. 1 business-telecom service provider.
However, this telecom giant fell down in 2002. The main reasons of its collapse can be explained
by the changes in competition and technology of telecommunication, specially those changes
which modified the long distance competition and created the Internet and the business related to
it.
This paper summarizes WorldCom history in the telecom industry contest and then tries to
explain the economic reasons of the company collapse. To reach this goal, this paper is divided
into 7 sections, in addiction to this introduction. The first section comments about the major
1
PhD student of economics at Universidade Federal do Rio de Janeiro – UFRJ.
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forces that have been reshaping telecommunications industry. Section 2 shows the USA
telecommunications ambient, presenting the main changes that influenced WorldCom
performance. Section tree summarizes WorldCom growth and section four tells about MCI
WorldCom merger. In section five, it is presented the history of MCI WorldCom from the merger
to the collapse. Section 6 presents and explains four reason to the collapse, based on economics
and technological changes that happened in telecommunications and, finally section 7 concludes
this work.
2. Competition in telecommunications
The telecommunications industry is one of the fastest-growing and changing in the world. It is
also technologically complex. The industry experienced two distinct phases. Until 1980, a
“analogical-monopolistic” structure prevailed in the sector, when there were monopolies offering
telephone service upon electromechanical technologies in almost all the countries. Since the
decade of 80, the structure of telecommunications has become “digital-competitive”, because of
the fast technological change, with the gradual network digitalization, and a vast set of
institutional reforms in the majority of the developed countries and in development. In the last
two decades three forces have transformed the industry: technological change, institutional
reorganization, and globalization. These factors intensified competition in the telephone business
segments in an asymmetric way. While local fixed telephony kept its monopoly characteristics,
competition fell down barriers to entry in the long distance segment (VARGENS FILHO, 2001).
2.1. Technological change
In a recent past all the information transmitted in telecommunication, basically voice, had a
analogical transmission, which copied the original forms of the signals. Now, all the information
that can be codified into bits can be transmitted. So voice, data, text and image can be transmitted
in form of bits upon the same network. This possibility increased the range of telecom services
which can be offered. The technical changes, specially the DSL technology, have also
rejuvenated the local copper networks, multiplying their capacity to transmit information and
increasing its intelligence. This way, new telecom services and the basic ones can be offered
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upon a big network, called ISDN (Integrated Services Digital Network), which has been built up
with the gradually digitalization of the old local networks.
According to Laffont & Tirole (2000), Networks were being rapidly enhanced to give greatly
increased carrying capacity for data as fiber optic cables replace traditional copper ones. Fiber
optic cables have a large capacity and a very low marginal cost. The fiber optic has been
substituting copper for presenting higher capacity of transmission, and thus reducing operation
costs and allowing to greater diversification and quality of the telephone services. The fiber is
used successfully in those parts of telephone network where there is great concentration of
signals, generally in the transport networks (backbone), responsible for the connection among
central switches. However, the copper wire is still the only viable alternative to the last mile,
since this network stretch presents low concentration of signals and great geographic dispersion,
what it becomes the difficult and expensive installation.
The local telephone network has high fixed costs of implantation and maintenance, and a high
marginal connection cost, this is, the cost of connecting a plus user. It occurs because of not only
the great capillarity of the copper pairs in the last mile, in result of the geographically dispersed
users, but also the impossibility to optimize these transmitters by commutation and multiplex
technologies. As the commutation is made in the local switch, each user must be individually
connected to the central office with a single pair of copper. Of this form, it is not possible to
rationalize the use of access network copper wires through commutation, as it happens in the
transport network (VARGENS FILHO, 2001).
In the long distance network, the investment is also high, but the marginal cost is minimum. The
transmitters used for long distance telephony can be maximized through commutation and
multiplex technologies, which endows them with great capacity of traffic, making that the cost of
a supplemental connection be very reduced. However, a long distance connection needs two local
connections to bind the users in the tips of the process. Thus, the great problem of the
competition in the industry is that the access to the consumer by last mile remains monopoly of
the local incumbent (Ibid).
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The wireless segment has been expanded beyond unwired phones and cell sites to include a few
strong satellite players. The evolution of the wireless industry has translated into a new-found
freedom for consumers, who can access information and communicate anytime and anywhere.
The mobile telephone market has increased rapidly in the world. It moved away from business
and elite users to the mass market with falling costs and the use of pre-paid cards. It is expected
the growth of the “mobile multimedia services”, i.e. mobile communicators with advanced
facilities for video, Internet/Intranet access, remote database interrogation, fax, e-mail and normal
voice communication. However, wireless is not an alternative to replace the copper pairs in the
last mile, since these technology does not yet provide the necessarily bandwidth to offer quality
and high speed in data services.
The principal innovation in telecommunications is the Internet, which has experienced a very fast
compound annual growth rate since the decade of 90. Internet can be delivered very fast by
ISDN, by satellite and digital mobile phones. It is much cheaper than the public switched
telephone network (PSTN): for example, in 1995 the ITU estimated the cost of sending a
conventional 42-page fax from New York to Tokyo was nearly US$29, while the Internet e-mail
cost of the same document was less than 10 cents. The high speed access to Internet is other
service which it is possible to add value. Firms offers this service placing a DSL access multiplier
(or DSLAM) in the central office of your local phone company. This piece of hardware, which
acts like a switch, transfers the data coming over the phone wires from a high-speed DSL
modem, onto their private networks and then to the Internet's backbone. With the develop of
Internet Protocol networks, voice over IP can be a alternative to the basic voice service. If the
quality improve, the voice over IP will push the price of voice traffic down over the next few
years.
2.2. Institutional reorganization
In many countries, previously separate and protected public monopolies have been broken down
and transformed in private companies. The governments so passed to regulate these companies.
There are two extreme ways to regulate telecom companies: as a private monopoly and as
competitive firms. Both ways bring problems to regulation. If the telecom operator is a private
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monopoly, the rapidly technical change produce a technological slack between firm and
regulator. In this situation, the information asymmetry between both can become so great to make
the regulation impracticable.
On the other hand, competition in telecommunications is very difficult and complex. The
institutional reforms in most countries divided telecommunications in two main segments, local
and long distance, and put separated firms to operate in each one. After a period of transitory
monopoly, these two segments have been opened to competition; first the long distance, later the
local one. Because of the local access to the customer remain a monopoly of local telephony
operator, competition was developed in the long distance but did not in the local segment. In
result, long distance carriers do not have means to access the retail consumers, still they are
connected to them by other access technologies, like wireless and cable TV, since these
technologies do not yet have capacity to support most part of the telecom data services.
Anyway, most regulators believe that competition is the best alternative for the
telecommunications industry. So, regulations have been relaxed in many cases, including the
USA, which possess the world's greatest and most competitive telecom market. US
telecommunications deeply changed with institutional reforms, like the introduction of long
distance competition in 1970, the AT&T breakdown in 1982, and the 1996 Telecommunications
Act, which will be analyzed at section 3.
2.3. Globalization
There is an effort to get the liberalization of the telecom national markets all over the world. In
1998, the World Trade Organization tried to implement an agreement covering 71 governments
and 91 per cent of telecom revenue to maximize basic market access for basic telecom services.
These agreement is part of the General Agreement in Trades and Services – GATS. Also in 1998,
the European Union expected the majority of EU Member States to liberalize voice telephony
and telecom infrastructure in that year, although exemptions on the deadline have already been
granted to less-developed members. This effort aims to open national markets worldwide to the
big long distance players can appropriate of the international traffic.
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The most visible aspect of globalization in the telecommunications industry is the sprouting of
“global service alliances” (GSAs) among telecom operators. This in turn is a result of the
internationalization of transactions and services and new technology in communications. The
growth in the scope of multinational companies has increased demand for “seamless” or “onestop shopping” provision of telecom services. The international traffic in telecommunications is
growing faster that the domestic traffic. The global services alliances were almost exclusively
traditional circuit-switched telecom operators offering fairly similar global services. However,
GSAs have change to respond to the advances in technology and new entrant telecom operators,
media and IT companies offering value-added services in the high value end of business process
solutions for multinational companies.
A good global strategic alliance can bring strong competitive advantages for firms which have
global interest like WorldCom. In 1997, the three key international strategic alliances were: i)
Concert Communications Services; which is $1 billion joint-venture communications company
created by BT and MCI in 1994 with seamless global products and services distributed by BT in
Europe and Asia/Pacific and by MCI in the Americas; ii) WorldPartners/Unisource which is a
fusion between WorldPartners, set up in 1993 by AT&T, KDD of Japan and Singapore Telecom,
and Unisource, a consortium of telecom operators from The Netherlands, Spain and Switzerland;
iii) Global One, which was set up in 1995 between France Telecom, Deutsche Telecom and
Sprint (USA) to operate in continental Europe (except the UK).
3. Telecommunications in USA
The USA has the strongest national telecom industry in the world, which accounts for
approximately one third of the total world's telecom revenue. Competition in USA’s
telecommunications was introduced in the 1970s, when MCI Communications Corp. became the
first company authorized to compete against the giant national telecom monopoly American
Telegraph and Telephones (AT&T) in the long distance market. Despite MCI was not a threat to
AT&T monopoly, it worked keeping a long distance call price-limit.
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To provide competition in USA telecom, the US Department of Justice broke up AT&T in 1982
into seven (now five) Regional Bell Operation Companies (RBOCs), with local telephone
monopolies. They became known as “Baby Bells”: Bell Atlantic, Bell South, Verizon, SBC
Communications and Quest Communications. Then, AT&T was confined to the businesses of
long-distance and manufacturing. After the AT&T brake-down, a lot of telecom carriers entered
in the long-distance market, specially to offer LD services to the business sector. Since them, the
long distance became progressively more competitive and the average price of a US longdistance call dropped by 70 per cent between 1984 and 1997.
At February 1996, the Telecommunications Act for the first time permitted local, long distance
and other telecommunications providers to enter each others' markets in the USA. It was the first
major revision and adjustment in the USA telecommunications law in it’s 62 years old. The 1996
Act opened the local telephony, which was Baby Bells monopoly until this time, and became
regulation less tight.
However, the 1996 Telecommunications Act did not produce competition into local telephone
markets, because of the technical characteristics of monopoly which the Act could not minimize.
Newcomers have so far not been able to enter in the local telephone market, which the Baby
Bells keep a 98% market share, as it is showed at Table 1.
Table 1 - US Telecom Market Shares in per cent (1996).
Source: Stonham (1998).
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The Telecommunications Act introduced a few significant trends that is shaping the future of the
industry. With barriers opening up between the various industry sectors, carriers are evolving
from specialists to generalists. With large companies gobbling up smaller competitors, as well as
companies from other industry sectors, a one-stop shopping environment is being developed.
With consumers able to cherry-pick a package of bundles services, including local, long-distance,
Internet, wireless and cable (in AT&T's case), only the strongest and most efficient companies
will be able to excel. In this process, the local incumbent have more advantages that the long
distance carriers, because the firsts have the local access monopoly.
By ruling that local telephone companies, long-distance carriers, and cable television operators
could enter one another's markets, the Telecommunications Act of 1996 cleared the way for interindustry competition and the convergence of technologies. However, this landmark legislation
barred the Baby Bells from offering long-distance service in their regions until they could prove
that competition was sufficient within their markets. To date, three of the remaining four Bells
have still been unable to convince the FCC that they have made the necessary progress in letting
other operators into their markets.
For local telephone companies, long-distance carriers, and cable providers alike, the act's
sweeping deregulation is a double-edged sword. On the one hand, a company can gain new
revenue sources by providing extra services and entering markets that previously were out of
reach. On the other hand, the added competition in all segments will result in tighter profit
margins for all players. However, these competition increased asymmetrically, and long distance
mark-ups were reduced faster than those of Baby Bells.
Once FCC permission is granted, the Bells could approach the out-of-region long-distance
market by buying capacity wholesale from existing long-distance carriers and reselling it to their
customers. This approach would involve little or no capital spending. In addition, the Bells, with
their huge customer bases, could negotiate volume discounts from long-distance carriers. With
respect to the in-region long-distance market, the Bells have two choices. They could buy
wholesale capacity and resell it, with the same benefits outlined above. Or they could build
facilities to link the local networks within their own operating territories. However, this tactic
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would likely cost several billion dollars. One other probably choice in the merger-mad telecom
industry is for these local carriers to seek out a long-distance acquisition or merger partner. This
would be the quickest and most effective option for these companies to pursue, and would spare
them the difficulties of building a new system from the ground up.
In the long distance, AT&T, MCI WorldCom, and Sprint Corp. have been actively competing
against each other for years. In fact, the market has been so cutthroat that AT&T's market share
slid to just over 40% in 1999, from all-encompassing prior to the company's break-up in 1984
(BW On line, 03/05/02).
4. The growth of WorldCom
The history of WorldCom is a history of a fast-growing and aggressive telecommunications
company from Misssissippi, practically unknown at the beginning of the 1990’s. In 1983,
WorldCom was born as a private company with the name of `LDDS' (Long Distance Discount
Service), as a long-distance telephone company in the wake of the AT&T divestiture. Receiving a
certification from the Mississippi Public Utilities Commission to operate as a long-distance
carrier, it began by reselling AT&T services to mid- and small-sized businesses.
In 1989 WorldCom went public on NASDAQ. Taking advantage of consolidation opportunities
by a reverse merger with Advantage Companies Inc. of Tennessee, it then acquired other small
long-distance resellers. In 1989, WorldCom's revenue base was US$109.5 million; in 1992
US$800.8 million after the takeover of Advanced Telecommunications Corp. (ATEL) of Atlanta
(STONHAM, 1998).
This very aggressive acquisition policy continued through 1993 to 1996, with the following key
purchases:
Table 2 - WorldCom major acquisitions (1993-96)
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Source: Stonham (1998).
All these acquisitions increased WorldCom's local and long-distance telecommunications
capacity not only inside the US but also abroad. By the end of 1996 WorldCom had revenues
totalling US$5,635 billion. In 1997, WorldCom had become the fourth largest facilities-based
telecoms services provider in the US, and as a result of its acquisitions policy, more diversified.
The 1996 takeover of MFS Communications and its subsidiary UUNet Technologies gave
WorldCom its strongest line of business for the future - Internet Services, and MFS increased
WorldCom's penetration of the local telecom market since it was a CLEC (Competitive Local
Exchange Carrier) (STONHAM, 1998).
Between 1993 and 1997 WorldCom pursued a strategy of transformation, connected with
acquisitions such as Wiltel, IDB and MFS/UUNet. It changed from a non-facilities-based reseller
of domestic long-distance services into a major facilities-based a end-to-end - still not integrated provider of local, distance voice and data/Internet services in the US and internationally. It could
combine all these services on one bill. Its facilities included 11000 miles of long-distance fiber
network and another 9,000 miles under construction, local fiber networks in 52 cities (45 in the
US), and one of the largest international data networks (Ibid).
Internationally, it had two transatlantic cables (built in partnership with C&W) and received
cross-border licenses in five European countries with plans to build the first pan-European
network. It also planned to quadruple UUNet's Network bandwidth and modem capacity by
spending US$300 million.
As Stonham (1998) observes, WorldCom's growth was impressive - outperforming its peers in
revenue and earnings growth and operating profitability. Since its NASDAC entry in 1989, it
recorded a shareholder return in excess of 50 per cent annually. It was estimated in 1997 that
long-term revenue growth would be 25-30 per cent and cash flow growth 30-40 per cent before
the MCI merger. On a stand-alone basis, the company was forecast to triple in size between mid1997 and the year 2000.
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5. WorldCom takes over MCI
In November 1997, WorldCom took over MCI Communications with the highest value corporate
bid in US history. But WorldCom was not the only bidder. For nearly a year, British Telecom
(BT) had been involved in merger discussions with MCI which reached an advanced stage. In
October 1997, WorldCom proposed the biggest corporate takeover in the US history for MCI. In
November 1997, GTE Corporation put in a competitive bid. Few days later, the WorldCom bid
was raised still further, producing the greatest merger in telecommunications history: MCI
WorldCom.
In 1997, MCI was the second largest long-distance provider of telecom services in the US (Table
1). It had also experienced flat earnings in the 1992 – 97 period. In 1996, its shares were trading
at the same level as in 1992. Its total revenues in 1996 were estimated about US$18,8millions.
Most part of then came from the long-distance market (89,5%). MCI's long-distance business in
the US was slowing down (21 per cent growth in 1995, 4 per cent in 1996 - the slowest on
record). The reasons was an increasing competition in long distance segment, with barriers to
entry and prices falling. Between 1997 and 2002 it was expected that the Baby Bells would make
a strong entry into long-distance business. This period (1997-2002) would be that of the longdistance business decline, for the reasons discussed at section 2.
According to Stonham (1998), the company responded to this crisis by attempting to refocus
strategically on larger, more profitable customers in the long-distance business, who used more
high-margin, value-added services, namely business customers to whom it could sell data
services. This was a less competitively-exposed segment by 1997. It also tried to enter the local
US telecom business in a meaningful way, but found it costly, complex and time-consuming,
even though this market was now liberalized. Revenues from local service operations increased
dramatically - but so did operating costs. MCI's new strategy included focusing on new ventures,
and this paid off. It made a $1 billion capital spending commitment, and revenues grew rapidly.
The key new ventures were: Systems House (the information technology unit), MCI Metro (the
local service business unit) and the cellular and paging unit.
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The first bid targeting MCI was made by BT, the principal British operator and one of the most
important global player, present in several countries over the world. MCI acquisition could not
only strengthen BT’s presence in USA telecommunication but also give BT skill in data
communications and software services.
The other intentioned in MCI was GTE, a large local exchange carrier in the USA. GTE was one
of America's oldest telecom businesses, which local exchange network was assembled from
many small rural telephone companies that were not absorbed by AT&T. It never became part of
the AT&T empire and is not a “Baby Bell”; it is known as an ‘incumbent' local exchange carrier,
and existed before the passage of the 1996 Telecommunications Act. As Stonham (1998)
observes, GTE/MCI merger would create a US$40 billion revenue company, with 21 million
local lines and 24 million long-distance ones, 5 million wireless customers and a major data
communications network. The merger could bring synergies in the US long distance and local
telecom markets for both companies.
But WorldCom was more voracious than BT and GTE. On 9 November 1997, WorldCom raised
its initial US$30 billions offer made on 1 October to US$37 billions, which was accepted by
MCI. The new merger agreement would pay MCI shareholders US$51 worth of WorldCom
common stock for each MCI share. This represented a 23 per cent premium to the $41.50 which
WorldCom first offered.
MCI WorldCom merger created a new major force in US telecommunications, although still
behind AT&T in total market capitalization. The company emerged from the fusion as the No. 2
overall telecom operator in the world, behind AT&T, and the No. 1 business-telecom service
provider. Even if its consumer long-distance business could not boast double-digit growth, it was
the cash cow on which WorldCom's other businesses have grown strong. With combined 1998
capitalization of US$60 billion and pro-forma revenues of US$32 billion, the new company
passed to serve 22 million customers, to control 25 per cent of US long-distance business, to be
the world's largest Internet provider (60-70 per cent control), to employ 70000 people and to
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provide telecom services in 100 US local markets. Together with AT&T and Sprint, the three
passed to control 85 per cent of the US long-distance business (Table 1).
According to Stonham (1998), WorldCom's local presence had been strengthened by buying
MFS/UUNet in December 1996, Compuserve and America Online in September 1997, and
Brooks Fiber Properties in October 1997. Following 40 deals like this between 1992 and 1997,
WorldCom had some nationwide local telecommunications operation. It also had fiber optic cable
in the US, fiber optic telephone networks in 86 American cities, global satellite coverage, and
undersea fiber. WorldCom's network of lines and switches increased MCI's infrastructure stock
four times - all the more important as MCI was finding it more costly to break into local
telephone markets than it had anticipated. MCI wove its InternetMCI and NetworkMCI data
services together with local/long-distance voice packages for customers and provided ‘one-stop
shopping’. In turn, WorldCom increased its share of the long-distance US telecom market from 5
to 25 per cent, as Table 1 shows. There is also some complementarity between client accounts.
MCI was strong in large corporate accounts, while WorldCom had a broad presence in carrier
accounts, small- to medium-sized businesses and Internet services. Also, MCI had superior
marketing skills to bring to the merger with well-known brands such as MCI Friends and Family.
But Stonham (1998) still observed that this strategy of mutual market penetration could not work.
The ‘Baby Bells’ were entrenched in local markets and willing to risk price wars to defend them.
Local call revenues were in fact forecast for slow growth only; MCI was facing long-distance
problems with tariffs falling by one-half in three years and those for international calls by twothirds in the same period; the Internet was beginning to be a clear threat to long-distance
revenues.
6. MCI WorldCom apogee and decline from November 9 1997 to July 22 2002
The long-distance telecommunications companies began this period with a mixed success in the
financial markets. As a group they were evaluated very well: as of December 1998, the Standard
& Poor's long distance index had rung up a 46.6% gain, compared with 20.2% for the S&P 500.
Looking at the companies individually, though, and wider variation emerges. MCI-WorldCom,
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the sector's frontrunner, was up 128% since January 1998, and Sprint has risen 38%. Only AT&T
trailed the market for the year, having climbed 19% (BW Online, 21/12/98).
The long distance companies were also fortunate that a number of the new frontiers which they
were exploring look promising, specially the value added services related to the Internet. Online
traffic was doubling roughly every three months, and all three long distance players wanted their
share. Data communications was growing at a double-digit clip. International phone markets
were also attractive at that moment because other countries were opening their borders to outside
competitors. Wireless communications showed as another market where revenue promised to
grow by 10% to 20% annually. And finally, Sprint, MCI WorldCom, and AT&T were all trying
to enter there in the $100 billion US local phone market.
In 1998, no telecom operator was doing a better job at that kind of refocusing than MCI
WorldCom, according to BW Online (21/12/98). Fresh from the merger, the company was
enjoying superstar status on Wall Street. Of the 32 analysts covering the stock, 25 rated it as a
strong buy, while another six had a buy recommendation on it. The reason was that MCI
WorldCom had set down promising roots in growth markets. It was one of the biggest handlers of
Internet traffic and provides access onto the Web for both America Online and Compuserve. In
Europe, meanwhile, MCI WorldCom operates a 2000-mile fiber-optic network linking 27000
buildings in the United States with 4000 in Europe - an attempt to attract large multinationals.
MCI's management had thus whittled down the company's exposure to the consumer longdistance market to about 20% of total revenues. To top it off, the company predicted that the
MCI-WorldCom merger could generate as much as US$2.5 billion in cost reductions. The
financial market believed that MCI WorldCom could increase earnings by 30% annually over the
next five years - and its shares were trading at about 35 times the US$1.95 per-share earnings
which the company was expected to bring home in 1999. The reason was that the market were
perceived the MCI WorldCom performance at the Internet, Europe, and some of the company's
other growth drivers, combined with cost savings from the merger.
During the years of 1998 and 1999, MCI WorldCom stocks were evaluated in the financial
market as one of the most profitable. In this period happened the “new economics” boom, when
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the stocks of new technology and Internet reached its top. MCI WorldCom was the
telecommunications operator which more strongly invested in Internet business. Financial
analysts knew that MCI WorldCom had the best IP assets than any other company in the world
and the most ubiquitous, pervasive backbone infrastructure in the world. The company's capital
allocation was skewed toward the fast-growing horizontal data/IP segments. Plus, WorldCom's
UUNet subsidiary carries over half the world's Internet traffic and has an IP network four to five
times larger than most IP backbones around the world. UUNet had as much value-added services,
IP VPNs and secured content as any IP player and future joint ventures with systems integrators
will spur growth in managed services.
On February 2000 WorldCom results were in line with the market estimates, with telephone
revenue growth of 15.36%. The revenue mix was growing at a positive rate, with 82% of
incremental revenues coming from data, Internet protocol and overseas. At this time, the margin
expansion was also significant, with EBITDA (earnings before interest, taxes, depreciation, and
amortization) margins 37.1% vs. 35.15% in the long distance group (AT&T, MCI WorldCom
and Sprint), up 1100 basis points vs. last year. Despite the scary Nasdaq sell-off on April 2000,
some financial analysts continued believing that technology and telecommunications shares were
still attractive for investors (BW Online, 07/02/00 and 10/02/00).
Also in the beginning of 2000, MCI WorldCom planned to merge with Sprint with an even
greater powerhouse. Sprint acquisition would benefit MCI WorldCom in two ways. First of all,
Sprint would fill a big hole in the company's product line - namely, a nationwide PCS presence.
Secondly, Sprint also had an advanced-telecommunications network known as ION [Integrated
On-Demand Network]. This would further enable MCI WorldCom to provide more broadband
services to its customers, becoming a still more aggressive player in both the internationaltelecom market and in the Internet-backbone market. But that merger collapsed in mid-July after
antitrust regulators indicated they were unlikely to approval the deal.
The MCI WorldCom golden age finished during the 2000 intermediary months when some
problems begun to appear, in addiction to the NASDAQ bubble crack. Competitions in long
distance decreased prices and revenues. Rates were dropping due to new competition and
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deregulation. Competitions increased not only among AT&T, Sprint, and MCI WorldCom but
also Baby Bells Verizon Communications and SBC Communications had started selling longdistance in New York and Texas, respectively. MCI WorldCom growth was offset by declining
wholesale access revenues, due to regulators forcing network operators, including the company,
to offer access to competitors at reduced rates.
The depressed stock price was a factor in the company's decision to make a potential
restructuring or spin-off of its consumer services. To remain competitive in the consumer
business, MCI WorldCom needed a local access which it just did not have. WorldCom believed
to be able to restructure its consumer services trough wireless access. It then applied for highspeed residential wireless licenses in more than 60 US markets nationwide, including major
metropolitan areas like Boston, Pittsburgh, and Providence. As for mobile wireless service, so
far, WorldCom was buying it wholesale from Sprint. It had managed to serve a million customers
cost-effectively this way. Another economical solution to the wireless puzzle would be to enter
into a co-marketing arrangement with a company like wireless giant Nextel. Still, most analysts
believed WorldCom had yet to come up with a wireless solution that would solve its consumergrowth issues long-term. However, the company was not able to restructure its consumer service
with wireless access, since wireless technology is yet costly and has limitations to data
transmission. (BW On line, 29/08/00).
From a five star rating in 1999, MCI WorldCom was downgraded in the financial market to four
star in 2000 and tree star in 2001. On Feb. 11 2002, Standard & Poor's revised its outlook on
WorldCom Inc. to negative from stable. As of Dec. 31, 2001, total debt outstanding on a nonlease-adjusted basis was about US$30 billion. The outlook revision reflected the current
economic and competitive telecommunications environment, which could challenge the
company's ability to deleverage its balance sheet near term. Revenue and EBITDA guidance were
revised downward for 2002 due to the economy and continued declines in the long-distance voice
business.
Although WorldCom turned free cash flow positive in the fourth quarter of 2001, which was two
quarters earlier than anticipated, total revenues for the quarter declined by 2.8% compared with
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the fourth quarter of 2000 and by 5% compared with the third quarter of 2001. This was primarily
due to a 5% decline in business data revenues resulting from the economic slowdown and the
continued decline in long-distance consumer voice revenues. In addition, EBITDA declined 6%
in the fourth quarter of 2001 compared with the fourth quarter of 2000 and declined 9%
compared with the third quarter of 2001. (BW Online, 11/02/2002).
Worried that the US$35 billion MCI WorldCom might be the next telecom giant to sink,
investors traded its stock down more than 70% at February 2002, scared by the carrier’s US$30
billion debt. It was not a problem when the company's hot data and Internet businesses were
growing 50%-plus in 2000. But now growth in these core businesses had fallen to the 10% to
20% range, WorldCom's interest payments exceed $1 billion annually, and its credit rating could
be reduced to junk. The financial market so perceived WorldCom´s problem: its US$30 billion in
debt was more than it can shoulder, given the sharp slowdown in its core business, the consumer
long-distance service (BW Online, 21/02/02 and 03/052002).
WorldCom faced weak demand for data services and a challenging operating environment in
2002. The company also faced a increasing pressure on management to restructure its MCI
tracking stock. Given the slower growth at WorldCom group, MCI would be increasingly asked
to shoulder a larger percentage of the allocated cost, preventing it from meeting its financial
obligations.
On June 25 2002, WorldCom announced that an audit committee had found that the company
improperly booked a total of US$3.85 billion in line-cost expenses as capital expenditures.
WorldCom said its EBITDA for 2001 and the first quarter of 2002 will be restated. The company
hid expenses and inflated cash flow by more than US$3.8 billion over five quarters. With this
scandal, MCI WorldCom was finally collapsed on July 22 2002 (BW On line, 28/06/02).
7. Why did WorldCom bankrupt?
The improperly balance operations were not the reasons of MCI WorldCom collapse, since they
seemed only an attempt to postpone or avoid the bankrupt. Some structural changes in
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telecommunications industry led MCIWorldCom to bankrupt because the company was not able
to adapt to the new telecom environment. According to Noam (2002), some factors have
happened in the industry since by the time of the Telecommunication Act and added their impact
cumulatively. Local competition failed; long distance competition, on the other hand, worked
only too well, lowering prices and profits; Wall Street became irrationally depressed when stocks
declined from their unrealistic heights; governments extracted future expected rents by auctioning
access to a vital resource, spectrum and; regulators, often beholden to incumbent´s well-being,
held back competitors.
The analyses of WorldCom history reveal a set of four basic reasons which left the company to
bankrupt. These causes refer not only to changes in the telecommunications sector but also to the
company manage stile and attitude. They are connected among themselves and jointly have a
satisfactory explanation to the company collapse. The four reasons are: i) the long distance
business slowdown, ii) the collapse of virtual business, iii) the fast growth of the company
through fusion and acquisitions and; iv) its financial aggressive posture. Each one of these trend
will be individually presented, despite its distinction may not be made in practice.
7.1. Consumer long distance service slowdown
As it showed in section 2.1, the fiber optic provided a revolution in telecommunications. Fiber
optic cables have a large capacity and thus incur a very low marginal cost. The optic transmission
impacted strongly in the long distance business. A lot of fiber optic backbones, in land or
undersears, were built by many competitors. As a result, there are now a lot of infrastructure, and
the price of each bit transmitted for long distance decreased dramatically. It affected basically the
long distance telecom operators, like WorldCom, which got his revenues from the long distance
retail traffic strongly diminished.
Why did long distance business decline? Because of the asymmetric competition, in result of the
technical changes and the institutional reforms, which reduced the barriers to entry in the long
distance segment but did not the same in the local one. The fiber optic reduced the marginal cost
of long distance transmission in relation of that of local transmission. Expecting a traffic
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explosion of data and voice, many new competitors could build fiber optic backbones to offer
long distance services. However, these entrants could not build local network facilities, which
keep monopoly of local incumbents. As a result, most part of the added value of a long distance
call is at the local network, and the long distance companies can not compete with the local
incumbent when these companies decide to offer long distance retail service because the long
distance carriers not only lack local facilities but also have difficulties to bill the retail consumers.
Data transmission in fact grew at a explosive rate, but the cost of each bit transmitted also
decreased at a similar negative rate. Then, the data volume growth could not generate revenue
growth, because of the increasing competition, promoting the long distance service slowdown.
The long-distance earnings have been declining by about 5% a year in US, because the telephone
companies risked a price war to increase market shares. MCI, for example, was offering flat rates
for unlimited long-distance calling.
Because of the long distance consumer business erosion, AT&T decided to spin off this market,
which was its core business for a long time. This decision reflects the ongoing competitive nature
of the consumer long-distance industry, which has resulted in pricing pressures and a loss of
market share, and the expectation that competition continues to negatively impact the consumer
long distance business. Thus, AT&T has been concentrating only long-distance corporate
business and data services.
Consumer long distance decline eroded MCI WorlCom’s principal source of revenue not only in
USA but also in other countries where its has subsidiaries. An example is Brazilian Embratel, a
carrier controlled by MCI which was negatively impacted with the long distance consumer
business slowdown.
7.2. The virtual business collapse
Most problems of the WorldCom emerged with the economic bubble explosion in 2000. The
1990’s was a long period of irrational exuberance, when the investors expect from of the
companies a very high and unreal financial return. These irrational expectations made enormous
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pressure on companies to they reach the desired goals. In fact, the bubble created an environment
so that everybody in the financial market and in the companies passed to behave more riskier and
aggressive. This behavior prevailed strongly on Internet business, since Internet companies were
over evaluated based only on future profit expectation, despite they did not have physical assets
and historical profits.
The consequence of this process was the bankrupt of almost all virtual companies. Therefore,
why did it happen? According to Porter (2001), the virtual companies saw the Internet as a
cannibal of traditional forms of competitions. But the Internet is a complement to old way of
competing, since it increase competitive advantages in addiction to those like brandname and
business competence. These represents important barriers to “dotcom” business that they just
would be able to develop.
When most of virtual firms began to collapse, the effects in telecommunications companies were
very hard, because they had bet in offering services related to the high technology. So, when
companies of Internet and technology bankrupted, the demand for telecommunications special
services - these of the highest added value and responsible for the most income-producing to
telecommunications companies - also fell. This process reduced the cash flow of the telecom
companies.
No telecom company was more damaged by the Internet business slowdown than WorldCom
was. The company strongly bet in the Internet business and had invested in Dotcom partnerships
and subsidiaries and had made strategic alliance with others virtual companies. In the truth,
WorldCom was the telecom company which played a key role in the development of
communications in the era of the Internet and globalization. During the NASDAC boom, the firm
over-esteemed demand for bits and made high investments in network facilities that were never
fully used. When the Internet business collapsed, WorldCom also slowdown. WorldCom
situation was still sharper than other telecom operators because the financial market connect the
company with the Internet business. It can be verified at Figure 1, which shows the WorldCom
stocks slowdown following the NASDAC bubble explosion.
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Figure 1 – WorldCom stock x NASDAC index.
Source: www.worldcom.com
7.3. WorldCom growth
WorldCom experienced the most rapid and greatest growth of all telecom industry history. This
growth was specially based on acquisitions, which brought operational and manage problems to
the company. In some acquisitions, WorldCom did not have conditions to run the new business in
addiction to its own.
In the MCI WorldCom merger, there were no more significant economies of scale and scope to
justify a fusion, because there was some overlap in the markets served by both companies. MCI
WorldCom emerged strong in long distance and data business, but it lack a nationwide local
access to retail customers. Therefore, a merger between WorldCom and one local incumbent
could generate more synergies than with MCI.
Still in the merger with MCI , the apparent strategic benefits and synergies that would come from
integrating were diluted, because of the difficult integration problems facing both companies.
WorldCom already had to fully integrate three existing networks before taking over MCI, and
lacked the management depth to run MCI's business in addition to its own. Still in MCI
acquisition, WorldCom was overplaying the financial advantages of merger to the detriment of
operational matters.
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With a growth based on financial bids and aggressive acquisitions, WorldCom did not develop its
network facility according the expansion of its consumer basis, like most telecom companies
traditionally did. In most part of WorldCom life, its network facilities were not appropriated to
serve its customers and the company did not have time to improve its competencies to function as
an integrated firm.
7.4. WorldCom financial posture
WorldCom had a rich history of acquisitions usually based on the strength of its own stock,
buying other companies, turning them around to enhance their value, and going on to other
acquisitions as its own stock rose in price. This strategy only worked at NASDAC boom times,
because the market was betting on the Internet business and some acquired companies had their
value overestimated at this times.
In the case of MCI acquisition, Stonham (1998a) argues that WorldCom paid too much for MCI,
after calculating how much value was added with the merger and how was value distributed
between both companies. According to the author, a successful acquisition is one in which both
the buyer's and the seller's stock prices will increase (frequently right as the acquisition is first
announced) because the value created as a result of the combination is shared by the two parties.
If the value added by the merger exceeds the premium offered, the buyer's stock price will rise.
Stonham (1998a) illustrates the distribution and net value which resulted from the value of the
bid and resultant share price movements at Figure 2, using the concept of net value added (lost)
which is the difference between total value received (by the buyer from the seller) and the total
value paid (by the buyer to the seller). This merger valuation is what the author called `win lose'. MCI won and WorldCom lost. MCI's gain was US$9.88 billion and WorldCom's loss
US$1.60 billion. Net synergies were therefore established at US$8.28 billion. This method values
MCI prior to the merger on the basis of its equity market capitalization.
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Figure 2 - Merger Value MCI WorldCom at MCI market capitalisation basis
Source: Stonham (1998a).
To conclude, Stonham (1998a) affirmed that: “America's biggest corporate takeover was clearly
going to be subject to close scrutiny by analysts and investors in the following months to the
deal's closure. The high price paid by WorldCom meant the delivery of estimated synergies was
critical to the merger's economic success, especially against a background of a stock market in a
mature bull phase.” (p. 10).
8. Conclusions
WorldCom history is closely related with the “new economics” boom, which was based on
Internet business. The lessons that can be extracted from this era is that Internet is not a
revolution that created new business and destroyed old ones. Internet is a mechanism to improve
old business, since it can reorganize all firm’s and industry’s productive phases. However, a
business needs old competitive advantages to succeed, like physical facilities and human capital.
Telecommunications does not differ from other business. The principal assets of a telecom
operator are its network and its customers. To growth, a telecom firm need to develop its network
to serve its customers efficiently, at a rate similar to that which its customer’s basis expands. A
big telecom company, like MCI WorldCom, must be sustained from basically telecom services –
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voice or data transmission. Of course the company has to offer special or value added services to
increase its revenue per customer, but these services are not able to be its main revenue source.
Among the lessons that the history of WorldCom gives, two of then can be outlined. First, the
evaluation of tech business must take in account the technological evolution and its impacts over
the competiton. Second, the institutional distinction between long distance and local telephone
segments does not make sense anymore, since a telecom operator, to succeed, has directly access
its customers and need to sell him a package with all telecom services.
9. References
BW Online. Long-distance Stocks May Have the Legs for a Marathon. www.businessweek.com,
21/12/98.
-------------. Salomon SB Agresssively Reiterates Buy Rating on MCI WorldCom Shares.
www.businessweek.com, 07/02/00.
-------------. Salomon SB Reiterates Buy Rating on MCI WorldCom Shares.
www.businessweek.com, 10/02/00.
-------------. Four Years Later, Telecommunications Act Reshaping the Industry.
www.businessweek.com, 03/05/00.
-------------. WorldCom at the Crossroads. www.businessweek.com, 29/08/00.
-------------. S&P Cuts Outlook on WorldCom to Negative. www.businessweek.com, 11/02/2002.
-------------. Why WorldCom Will Be Left Standing. www.businessweek.com, 21/02/02.
-------------. Saving WorldCom: An Impossible Dream? www.businessweek.com, 03/05/02.
-------------. WorldCom´s Sorry Legacy. www.businessweek.com, 28/06/02.
LAFFONT, J-J., TIROLE, J. Competition in telecommunications. Cambridge, MA: MIT Press,
2000.
NOAM, E. M. How telecom is becoming a cyclical industry, and what to do about it. Seoul: 14th
ITS Biennial Conference, International Telecommunications Society – ITS, 2002.
PORTER, M. E. Strategy and the Internet. Cambridge, MA: Harvard Business Review. March,
2001.
STONHAM, P. Takeover frenzy in telecons: the case of MCI WorldCom. Part One: Competitive
Strategies. In: European Management Journal. Oxford, UK: Elsevier Science Ltd., vol. 16,
No. 3, p. 318-326, 1998.
STONHAM, P. Takeover frenzy in telecons: the case of MCI WorldCom. Part Two: Financial
Bids. In: European Management Journal. Oxford, UK: Elsevier Science Ltd., vol. 16, No. 5,
p. 562-572, 1998a.
VARGENS FILHO, J. R. Concorrência e universalização na indústria de telecomunicações
brasileira: o problema do unbundling. Salvador: Faculdade de Ciências Econômicas da
Universidade Federal da Bahia (FCE/UFBA), Dissertação de Mestrado, 2001.
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