When the telecommunications market started getting rough two years ago, some people foresaw, correctly as it turns out, an enormous amount of consolidation in the industry. The land rush in the wake of the promise of limitless demand for data communications had attracted well over $1.2 trillion in capital investments in a period of less than five years. It almost went without saying that some of these investments were going to come for naught, because there has never been an industry that could absorb that much capital in such a short period and provide adequate returns. Whenever there is the sniff of easy money, rest assured that some poorly capitalized, overmatched "me-too" companies will congregate. In the United States, there were more than 3,000 telecom companies in 1999. Almost none would survive -- a fairly predictable outcome.
I don't think that there were many scenarios being built that had MCI and WorldCom (Nasdaq: WCOM) being wiped off the map. WorldCom was the acquisitive opportunistic carrier, MCI the second-largest long-distance carrier in the U.S., and their merger created the largest long-haul data transport provider in the world. Even if the worst case were to come to pass (Surprise! It did.), MCI was supposed to be a survivor.
WorldCom finds its shares in penny-stock range, trading yesterday as low as $3.22 per share, placing it at a market cap south of $10 billion. Now, don't get me wrong. A $10 billion company is massive, but there was a point in time not so long ago that WorldCom was valued at more than $200 billion. Let me put this in easier terms: If you owned all of WorldCom, in the last two years you would have lost $190 billion. Dollars, not yen. It's sort of like trading the economy of Austria for that of Sri Lanka.
Often a cheap stock is a bad sign
Fortunately, we don't have to invest in the WorldCom of the past. If we want to, we can invest in the WorldCom at today's prices, with its $35 billion in revenue and $1.3 billion in earnings for fiscal 2001. WorldCom is still one of the largest telecom providers in the world, and is still a major player in what remains a major industry with massive growth prospects. What we want to do with Rule Maker is buy great companies at times when we believe that the market has mispriced them. Well, WorldCom has dropped by nearly 80% since January 1, so it is entirely possible that it was either priced too high then or too low now.
Well, I've got to tell you: The market has WorldCom priced as if it were going to destroy every last penny of equity. It has a price-to-book value of 0.21, and its liquid assets nearly equal its market cap. That is simply absurd for an operating company. Ah, but not so for an operating telecommunications company. Here is the most absurd thing: MCI (Nasdaq: MCIT), WorldCom's long-distance telecom tracking stock, has a dividend yield at this writing of 56%.
One of the things I want to do with the Rule Maker Portfolio is to find companies currently out of favor that have above-average economics and offer what I might consider to be a strong valuation. But sometimes an enormous drop in share price isn't about an opportunity -- it is, rather, the last ride for a company that is dead but doesn't yet know it.
For all of the discussion about the collapse of voice communications, the actual usage is still spiraling upward. There may not be a more repetitive use product than telecommunications. And this is a business, for all of its commodity characteristics, that is still dominated by the major players: AT&T (NYSE: T), Sprint (NYSE: FON), SBC (NYSE: SBC), WorldCom, and so on.
However, there are several problems in this business. First of all, per-minute rates for voice communications have plummeted, leaving very little margin at all for carriers. Where, once upon a time, a 10-cents-per-minute rate was revolutionary, now the rates approach a nickel, and international service rates have plunged even faster. Second, the waters remain extremely muddy due to the large number of failing telecoms. These companies are desperate for cash, and, as such, they have no motivation even to sell service above their costs. They need cash to service the massive amount of debt racked up during the building boom. Even the healthy carriers (and there are a few) get mauled in such an environment, as the market's notion of "competitive pricing" is artificially depressed. And, third, although data traffic continues to grow rapidly, the promised economic returns for providing such services have yet to come to pass.
If it sounds ugly, well, that's exactly why WorldCom is sitting a hair over $3 a stub. For the most part, at least.
WorldCom's building and buying binge has saddled it with more than $30 billion in debt. For a company that has shrinking revenues, such a big debt number ought to be unnerving. Fortunately for WorldCom, very little debt servicing is due through 2002 -- about $800 million, $172 million of which is principal. In 2003, the amount of principal due to be paid is $1.7 billion. Keep in mind that, in this past year, WorldCom generated $108 million in free cash flow, and it has on hand about $1.4 billion in cash. It has other liquidity options, but this low level of cash generation from operations cannot instill much confidence.
Of course, that's why the stock has been shellacked. Is the market providing us with an opportunity to own a good-to-great business at a minimal price? It's certainly possible, but I don't think that WorldCom's got the correct pieces in place, nor can it count on any general improvements in telecom prospects.
That's the real problem here. WorldCom's CEO Bernie Ebbers has proven beyond a shadow of a doubt that he can build an empire, but has he shown much competence at running a company or, more importantly, at turning one around? Not really. Nor has WorldCom's board given any sign of being willing to step in and act in the best interest of shareholders, as evidenced by their willingness to loan Ebbers a third of a billion dollars rather than have him sell shares to cover a financial problem. Add to this the scrutiny of the Securities and Exchange Commission on WorldCom's accounting, and you have a big fat mess.
Besides that, how was the show, Mrs. Lincoln?
There is a variant perception, though. It is that WorldCom has enough assets to sell and enough receivables to factor and enough creativity in its management stable to survive the downturn. I would say that this argument is at least partially valid. The trouble comes if WorldCom starts violating terms of its debt covenants -- by share price, credit rating, or other performance criteria. In this case, the flood of debt payments could overwhelm the company, forcing a restructure -- rarely a good thing for equity holders.
I don't have much confidence in the scenarios that have WorldCom collapsing -- it has far too many sellable assets. At the same time, in a commodity business, even a branded commodity one, investors simply must look to align themselves with a superior management that has shown great evidence that it has their best interests at heart. With WorldCom, history suggests that we are 0 for 2.
It's an intriguing turnaround play, but it's got too many questions about its core business and capital structure to be a Rule Maker.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
In this extra-special episode of Blossom, Bill Mann explains to Joey Lawrence how his fame could be both too long and soon ending at the same time. Bill owns none of the companies mentioned in today's article. The Motley Fool is investors writing for investors.
