Strategic Analysis – Evaluating Worldcom’s Aggressive Business Strategy

[pic 1]

1. Strategic Analysis

 Strategic Analysis – evaluating WorldCom’s aggressive business strategy

In 1983, Mississippi businessmen Murray Waldron and William Rector launched a company named Long Distance Discount Service(LDDS) whose business was to resell long distance phone service. In 1985, Bernie Ebbers became the CEO of LDDS, and made LDDS public in 1989. In 1995, LDDS changed its name to WorldCom.

Ebbers had no background in telecommunications, yet he was an aggressive businessman and compulsive deal-maker. His characteristics had a great influence on WorldCom’s future operations. In his view, the way a company grows its business is to merger and acquisition.

In the beginning, LLDS was just a reseller of long distance phone service. To acquire more customers, WorldCom purchased Advanced Telecommunications Corporation. To acquire the ability to provide service, WorldCom purchased Metromedia Communications Corporation and Resurgens Communications group. To provide better service, he purchased IBD Communication Group and Williams Telecommunications group. Lastly, he purchased MFS Communications, as the most significant acquisition, provided WorldCom local network access and a leading Internet provider for business customers.

The goal of WorldCom’s mergers and acquisitions was trying to obtain end-to-end ownership of the networks, WorldCom became not only a network service provider, but also a network carrier and operator. With those acquisitions, WorldCom was growing rapidly.

However, in 1996, the Telecom Act, which cleared the way for other telephone companies to enter the long distance services,  resulted in fierce competition in telecommunication industry. Long distance carriers and local carriers all get unprecedented opportunities for development. Telecom was the hottest industry all over the world in 1997. In this situation, WorldCom offered overvalued price to purchased MCI, which was the second largest long distance carrier, in order to expand its market share and to lower its cost.

WorldCom was the biggest carrier of Internet traffic, No.4 long distance provider, and MCI was the No.2 long distance provider. With this acquisition, MCI could save 45 percent fee which they used to paid for networks. MCI had special strengths in the residential market, while WorldCom focused on widespread business customers. WorldCom’s massive fibre would bring MCI better international connections and it also expected to fix MCI’s management problems. On the other hand, MCI had good reputation for innovations which could potentially leverage WorldCom’s brand name. This merger was expected $2.5 billion costdown in first year and $5 billion costdown in five years. This acquisition seemed to might help WorldCom bring their cost down, expand their market share, improve innovation, and get good reputation.

Deal-making and buying companies became the core competency of WorldCom. Their profit largely came from salesforce and customer base, which caused low gross margin compared to those company with good innovation capability. However, WorldCom had a effective cost control capability.

On the level of strategic, WorldCom’s profit model was very simple, mostly depended on the long distance business and thus this model is risky. Furthermore, WorldCom missed the opportunity to enter the wireless market, which was dominated by Sprint and AT&T.

After the acquisition, the company’s economic situation is not very good. So Ebbers began to govern MCI’s corporate culture. The company implemented conservation actions from top to bottom. Those strict cost control measures lead 2,215 people laid off, including 70% MCI executives.

Between 1996 and 1999, the Telecommunication Act period, 147 resellers entered the market, which lead the competition become really intensely price-based. As a result, MCIWorldCom was squeezed at the revenue end. During the same period, demand supply was much more than demand, which squeezed the industry operating margins. MCIWorldCom had to slow down its growth and profit expectations.

In 2000, wireless industry improved and became more widely used, and even resulted in cost saving and attractive promotions. MCIWorldCom proposed to acquire Sprint to make up the wireless market. However, this merger was rejected by U.S. Department because of the bad performance of the acquisition of MCI. Because of the rejection, WorldCom’s stock price fell sharply, its debt level reached an unsustainable proportion, and its balance sheet was obviously in danger.

In late 2000, MCIWorldCom divided into two groups: WorldCom was responsible for business and commercial customers while MCI focused on retail and small business. WorldCom was expected to catch the web service opportunities. However, because of penny-pinching culture, innovative lackness, and poor customer service, and most important, lack of wireless market made MCIWorldCom’s revenue still declined. In 2002, WorldCom filed bankruptcy.

1. Situation Analysis

Situation Analysis –  existing and projected interest rates, the “spreads” on the costs of debt for corporate borrowers, and the impact on possible terms and conditions for debt

In November 1997, “financial community was shocked by a $37 billion bid of WorldCom for MCI Corp. In January 1998, WorldCom filed a shelf-registration statement seeking to raise $6 billion, and WorldCom planned to use its own stock to buy the public shares of MCI” (Harvard Business Review). As the deal, WorldCom would pay cash for the 20% stake in MCI. With the merger of MCI, investor’s awareness and interest was boosted, and had responded favorably to the merger. From the date Nov. 10, 1997 that MCI agreed to be bought by WorldCom to July 31, 1998, the share price  increased 57%, While the S&P 500 increased 22% and  industry index increased 40%.  In addition to the MCIWorldCom merger, WorldCom reported 45% increase revenue and almost 5 times net income over the same period of the previous year. It was widely believed that WorldCom’s debt would be upgrade.

However, in June of 1997, the devaluation of the Thai currency precipitated a major financial crisis in Asian. In mid-July of 1998, with the fears of crisis resurfaced, the currency of Japanese and China were also devaluing. In the second quarter, a slowing corporate profitability showed in the domestic U.S. economy. Additionally, increasing political crisis threatened the U.S. equity markets. The Dow Jones Industrial Average suffered a historic dropped, Similar situation happened for the S&P 500 and NASDAQ averages. Due to Asian crisis, investors’ interest had moved from equities to corporate bonds and Treasuries. Corporate yield spreads over Treasuries had increased from January, 1997 to July, 1998, which means the projected interest rate of corporate debt will increase. Borrowers would have to pay higher interests to the lenders for the debt offering. Additionally, large volume of debt issuance was coming in August. The large demand for money from companies and borrowers lead to higher demand of interest rates by the lenders. With the current market situation at that time and many corporations issued debts, there were more risks associated with lending money.  Those factors would lead to a great possibility that WorldCom have to increase the bond spread in order to attract investors’ interest and make them willing to take on the risks associated with buying WorldCom’s bonds. Investors too would be strict in their terms and conditions of collaterals, yield to maturity and interest rates in case companies could not pay back the money.