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The SEC goes Goodwill Hunting at WorldCom

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DQI Bureau
New Update

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.

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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.

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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

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