S&P: What WorldCom Means for Telecoms

NEW YORK -- WorldCom Inc.'s Chapter 11 filing on July 22, 2002, the largest in corporate history, highlights the weak state of the telecommunications industry, Standard & Poor's Ratings Services said today. The financial markets, which were already closed to all but the strongest service providers in the industry, will raise the risk premium for the remaining companies in the sector. Venture capital interest in the industry is also expected to wane further due to the WorldCom filing and related accounting improprieties. Any potential investment in telecoms by private investors will take longer because more scrutiny of a company's accounting will be required.In addition, the financial woes of WorldCom have exacerbated asset valuations to the downside, an area that was already reeling from the overcapacity of the 1990s. However, Standard & Poor's expects that the FCC and state regulators would want WorldCom to continue operating, albeit in a reorganized structure, to provide appropriate customer service levels and also to preclude the "dumping" of more telecom assets at fire sale prices. The fallout of WorldCom will also reverberate throughout the economy as the company continues to reduce staff, cut supplies from vendors, and require fewer access services from incumbent local exchange companies. These factors, in turn, will contribute to the cycle of lower telecom revenue growth for at least the next 12 months.Over the past few days, second-quarter results reported by BellSouth Corp. (A+/Stable/A-1) and SBC Communications Inc. (AA-/Stable/A-1+) exemplified the weak environment for telecom services and continued slowdown in telecom spending by business customers. However, the regional Bell operating companies (RBOCs) will be survivors in the telecom shake-up because they benefit from a diversified revenue mix and 100-year history. Also, they are still regulated to a certain degree, which has resulted in their financial records being scrutinized by state and federal regulators. AT&T Corp. (long-term BBB+/Watch Neg, short-term 'A-2') and Sprint Corp. (BBB-/Stable/A-3) will likely benefit in the short term from the WorldCom bankruptcy by gaining some business enterprise customers that decide to switch carriers or wish to have alternate sources to support their voice and data traffic.Consolidation among the RBOCs and long-distance carriers is unlikely in the near term due to regulatory constraints. Furthermore, WorldCom is not an attractive acquisition candidate now because of ongoing SEC and Department of Justice investigations and litigation surrounding the company. In addition, there is too much uncertainty regarding the quality of its financial statements. WorldCom's revenue base, particularly the residential segment, has already been impacted by wireless and e-mail substitution and RBOC entry. The value of its assets is primarily based on its business enterprise customer list.Unlike its support of the airline and steel industries, an outright bailout by Congress of WorldCom would be difficult due to the alleged fraud committed by the company's senior management. As the company works through the bankruptcy process and more clarity emerges concerning its restructured balance sheet, regulators may encourage a private investor to take an interest in the company. This would result in maintaining a major competitor to the RBOCs-the spirit of the Telecommunications Act of 1996-and helping re- establish investor confidence in the industry.The WorldCom bankruptcy has wounded the telecom industry, but businesses and consumers will continue to make phone calls and use the Internet. The telecom infrastructure is essential to all levels of government and national security. The industry is not going away. But it can no longer be viewed as a high-growth industry as it was in the boom of the 1990s. Moderate growth rates in the mid-single digit area at best are expected in the future.Re-establishing investor confidence in the industry is dependent upon clarity from regulators, accounting transparency, and increased demand for telecom services.Standard & Poor’s