Credit analyst says WorldCom hasn't reached bottom yet

By Ronda Fears

Nashville, Tenn., April 22 - WorldCom has not reached a bottom from a credit standpoint, said Carol Levenson, director of research at Gimme Credit. And, the analyst said WorldCom's lower projections still may be too optimistic amidst a flagging telecom industry.

While virtually every other global communications provider for the digital generation has been adjusting expectations lower, WorldCom (A3/BBB+) had been strangely silent, Levenson said. Then, late Friday the company finally confirmed the rumors of sales and cash flow shortfalls for this year.

"There's an interesting chronology of events over the past several weeks, leading us to believe management didn't suddenly wake up on Friday and realize the WorldCom Group would fall short of its 2002 EBITDA projections by 10 to 20%," Levenson said in a report Monday

"Although WorldCom is relying upon the time-honored method of maintaining its free cash flow projections, despite lower EBITDA, by cutting its capital spending plans, we wonder whether its assumptions are still too optimistic."

Because of lower voice, Internet and data volumes, management has lowered its projection for 2002 WorldCom Group EBITDA by roughly $1 billion to $1.5 billion to $7 billion to $7.5 billion. This would represent a decline from last year in the mid-single digits to the mid-teens instead of a mid-single-digit increase.

Management already guided down 2002 revenue and earnings expectations in early February, Levenson noted. She added that the implied EBITDA margin in the new guidance, instead of holding even with last year, shows a 300-500 basis point decline.

However, management still sees free cash flow for the consolidated company of $1 billion.

"By our calculations, this would only be true if EBITDA comes in at the high end of the projected range, barring further decreases in capital spending and assuming working capital remains a cash flow helper," Levenson said.

"The new EBITDA forecasts mean total debt/EBITDA could go as high as 3.5 times this year, and call into question the amount of an impairment charge the company could have to take on the $47 billion in goodwill and intangibles on its balance sheet."

Before this outlook change, she said, management was projecting a charge in the $15 billion to $20 billion range.

While WorldCom is not currently using its bank facilities, and maturities are light this year, it will need the banks in the future, and the bank facilities contain a leverage clause that does not make an exception for goodwill impairment charges.

"In hindsight, it appears S&P must have known something of all this when it decided to review the company's short-term and long-term ratings for a downgrade a couple of weeks ago, days after affirming current ratings," Levenson said.

"The inclusion of the short-term rating in this review, of course, implies the rating agency is contemplating a long-term rating downgrade of at least two notches."

As for the "mysterious action the company took earlier this month in calling its $700 million in remarketable securities," the analyst said she never interpreted it as a positive move. WorldCom's other options were to remarket the bonds or exchange them for term debt at market rates.

"Since these were WorldCom's lowest coupon bonds, at 6.125%, they don't appear to be obvious candidates for a cash call," Levenson said.

"This leads us to believe something, perhaps the SEC investigation or a bond market with no taste for WorldCom debt, prevented the company from exercising its other options with regard to this issue."

As for management's spin that the company was using its strong cash flow to pay down debt, the analyst question the viability of that as well.

"WorldCom's increase in cash in the first quarter, the cash used to call the bonds, roughly equals the sale of its News Corp. stock, and with debt unchanged, this leads us to believe free cash flow in the quarter was breakeven at best," she said.

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