The SEC goes Goodwill Hunting at WorldCom

ON Mar 11, WorldCom joined Gobal Crossing and Qwest Communications on the
list of telecom companies with accounting practices that are under review by the
Securities and Exchange Commission. The telecom giant says it’s cooperating
fully. WorldCom Inc. chief financial officer Scott D Sullivan said the company
has been reviewed repeatedly in recent years and satisfactorily answered all
questions.

Still, the inquiry poses a real danger. The SEC requested documents on a
sweeping range of topics, including disputed customer bills, sales commissions,
and WorldCom’s loans to its officers and directors. The latter would
presumably include the $340 million that CEO Bernard J Ebbers owes the company.

Perhaps most serious of all, the SEC wants information about how WorldCom
accounted for the goodwill it built up while acquiring 60 companies, including
long-distance player MCI Communications. Goodwill is an accounting term that
describes the amount by which a purchase price exceeds the value of the acquired
company’s tangible assets. WorldCom’s goodwill swelled to $50.8 billion at
the end of September. Under new accounting rules, a company needs to write down
its goodwill if the value of the acquired company suffers a sustained decline.
Already, WorldCom has said it will take an estimated $15 billion to $20 billion
charge to write down its goodwill. However, the SEC inquiry could force WorldCom
to take a bigger write-off, says credit analyst David Peterson of Fitch Inc. in
Chicago.

That could create a cash crunch. The Telecom Company now has an $8 billion
bank credit line that it can draw on if it needs additional cash. Those untapped
loans require that WorldCom keep its debt-to-capital ratio at 68% or less.
Today, WorldCom’s ratio is 34%. A $20 billion writedown would up that to 44%,
according to Merrill Lynch & Co. WorldCom would pass the 68% threshold if
its write-off exceeds about $45 billion. "The SEC inquiry certainly raises
the possibility that a larger writedown in goodwill may be needed," says
Douglas R Carmichael, an accounting professor at Baruch College, who says it’s
possible that WorldCom may have to write off all of its goodwill since the
telecom industry is so troubled. WorldCom dismissed the scenario. "The
prospect of a larger writedown is hypothetical and we certainly don’t expect
it to play out," says company spokesman Brad Burns.

Without access to its bank credit, WorldCom might have trouble making
payments on its debt. Those payments total $172 million this year. But WorldCom
is supposed to repay $1.7 billion in 2003 and $2.6 billion in 2004. Ebbers says
WorldCom won’t fail. "WorldCom is a viable entity going forward," he
says.

Yet supporters are abandoning ship. Merrill Lynch analyst Adam Quinton
downgraded WorldCom from a "buy" to a "neutral" just before
Ebbers took the stage at the Merrill Lynch conference Quinton was hosting.
Quinton said it was inappropriate to have a positive rating given the
uncertainty of the SEC inquiry. Those doubts won’t be dispelled any time soon.

By Steve Rosenbush in New York in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc