MCI: Ringing in Reform

When the audit committee chairman foresees ''a substantial amount of work,'' emerging from the biggest bankruptcy in U.S. history may be only half ...
Craig SchneiderOctober 21, 2003

There’s no rest for the bankrupt.

Indeed, MCI managers have been locking horns with regulators and creditors for months, endeavoring to emerge from beneath the largest bankruptcy in U.S. history. The telecom company also plans to shed its old WorldCom skin, hoping to distance itself from an $11 billion accounting-fraud scandal and reinvent itself as a role model for corporate governance and ethics.

By most accounts, MCI’s fate now rests in the U.S. bankruptcy court for the Southern District of New York, where the company will face a final vote on its reorganization plan. Bob Blakely, MCI’s chief financial officer, announced last month that it is “on track to emerge from Chapter 11” following a settlement with two dissident creditor groups that opposed the plan.

One creditor group, originally slated to get nothing under the plan, will now reportedly be paid 44.5 cents on the dollar; the other group, originally scheduled for 36 cents on the dollar, will now receive about 52 cents. If all goes well with the bankruptcy judge, MCI’s debt load would undergo the equivalent of corporate liposuction, dropping from $32.5 billion in debt to just $5.5 billion.

Dennis Beresford, a member of MCI’s board of directors and chairman of its audit committee, is not celebrating just yet, however. “We still have a substantial amount of work to do,” says the former chairman of the Financial Accounting Standards Board, noting the massive restatements that still await. “We are still going through and making the appropriate changes as a result of the accounting fraud that took place.”

Ruin to Role Model

It’s been more than a year since WorldCom fired CFO Scott Sullivan after uncovering accounting irregularities of $3.8 billion in expenses that hid a net loss for 2001 and the first quarter of 2002. Additional re-audits looking as far back as 1999 have since ballooned WorldCom’s improper booking to $11 billion.

Shortly after the scandal broke, WorldCom filed for bankruptcy and hired former Hewlett-Packard president Michael Capellas to replace Bernard Ebbers, on whose watch Sullivan’s alleged illegal bookkeeping took place. MCI also agreed to a settlement with the Securities and Exchange Commission in which the company would make a $750 post-bankruptcy payout to shareholders.

MCI’s board, which was subsequently fitted with independent directors such as Beresford, adopted 78 new and somewhat radical corporate governance reforms intended to restore investor trust and institute internal controls where apparently there were none. “One cannot say that the checks and balances against excessive power within the old WorldCom didn’t work adequately,” noted Richard Breeden, MCI’s bankruptcy-court-appointed monitor, in his governance report. “Rather, the sad fact is that there were no checks and balances.”

The General Services Administration (GSA) came to a similar conclusion in June and suspended WorldCom’s eligibility to bid on government contracts, on the grounds that it lacked “the internal controls and business ethics necessary to be considered ‘presentably responsible.’”

MCI is working on it. In the coming months Beresford plans to wrap up the necessary restatements associated with the accounting scandal under former management, so that by the time the company exits bankruptcy protection, only accurate records remain. The trouble, he says, is picking through the company’s highly fragmented accounting system — the byproduct of years of poorly integrated acquisitions made by former finance chief Sullivan.

“It’s been the Achilles’ heel for the organization, and we want to make it the opposite — a very valuable contributor to the success of the company,” says Beresford, who also serves as a professor of accounting at the University of Georgia. “The accounting records were frankly in shambles.”

Beresford noted 27 different accounting systems to record revenues. “Clearly,” he says, “that’s not an efficient way to operate.” The systems still include a manual override. Beresford observes that “senior accounting leaders were either making or authorizing some phony adjustments that overrode the results of the basic accounting systems.” The override function, he adds, will need to be eliminated in an eventual system upgrade.

Blueprint for Action

Breeden’s report for MCI’s governance is also expected to help convince the GSA to drop its ban. Aside from several internal controls, one of the dozens of new initiatives to restore trust will be to improve shareholder communication through an open investor forum. Specifically, the board of directors is required to establish an electronic “town hall,” where shareholders will be able to communicate directly with the board and to propose resolutions for consideration, whether or not the resolution would be allowed under SEC proxy regulations.

The company has taken other measures to ensure that the improper acts of the past stay in the past. Aside from retaining new C-level executives from outside MCI, the company has restructured its accounting department and accounting functions, doubled the ranks of the internal audit staff, and instructed that function to report directly to the audit committee of the board. The company has also established a corporate ethics office and a zero-tolerance policy for any actions that do not meet the highest standards of integrity.

If MCI isn’t re-certified to bid as a government contractor until July 1, 2004, the company has warned that the loss of business would reduce revenue by nearly $1.02 billion and earnings by $250 million over three years. Still, the loss of government contracts isn’t expected to have any effect on the feasibility of its plan to emerge from bankruptcy.

Beresford, however, wants MCI to be “best of breed” in corporate governance and ethics. “We can’t afford to be anything less,” he says. “With all of the problems we had in the past, we can’t just become acceptable, [by implementing] a bare minimum of compliance.”

I Just Called to Say I’m Sorry

While few would argue with improving MCI’s governance and ethics, not everyone agrees that changing the company’s name from WorldCom will do anything to restore the public’s trust.

Mike Paul, president of MGP & Associates PR, calls the idea “a huge mistake.” “Everyone knows that MCI equals WorldCom,” says Paul, a former managing director of business strategy and marketing at the old MCI before it acquired WorldCom. He adds that the general public is willing to forgive and forget when they’re told the truth, starting with a humble apology. “Crisis PR and reputation management starts with ego management,” he says.

Peter Ausnit, an investor-relations consultant based in California, begs to differ when the general public is the investing public. He notes that a mea culpa can be a costly statement to make, however grand the gesture. Consider, he says, that Cendant Corp. “suffered for their honesty,” paying a record $3.2 billion settlement in a class action lawsuit against a predecessor company.

“There’s no analyst that can assess the risk of WorldCom until after the state attorney general or regulatory agencies finish their cycle of litigation,” says Scott E. Wendelin, CEO of Prospect Financial Advisors. “That can be years.” The real litigation risk is in the civil courts, he adds, where “it’s open season for the foreseeable future.”

Litigation aside, Gary Hindes, managing director of Deltec Asset Management, thinks management is better focused on the future. “I think the accounting scandal is a thing of the past,” he says. “I don’t think people think of that when they dial one plus an area code.”

If You Rebuild It, Will They Come?

Eric K. Tutterow, a high-yield bond analyst with KDP Investment Advisors, believes that MCI will emerge from bankruptcy a much stronger player in the telecom space. Under the reorganization plan, most of the debt holders will own new equity of the new MCI.

Tutterow also makes some conservative assumptions in his calculations for valuing bonds — for example, that post-bankruptcy, MCI will have to pay out $1.5 billion to shareholders, double the $750 million already settled on with the SEC. The company has about $3.5 billion in cash on its balance sheet.

With just under $400 million in debt service or interest payments, the majority of the cash flow — over $4 billion expected in fiscal 2004, up from nearly $3 billion this year — can be used to reduce debt further or increase networks. “With those leverage numbers, on the surface,” says Tutterow, “they could emerge as an investment-grade company.”