Dilemma Deepens at Shrinking WorldCom

The big telco slashes 5% of jobs, but the truly hard choices lie ahead, analysts warn.
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Just when you thought

WorldCom

(WCOM)

was putting its troubles behind it, a whole new worry is rearing its ugly head.

The nation's No. 2 long-distance company rolled out a 5% staff cut Wednesday, as it slashes costs to keep up with heavy debt obligations and sliding revenue in its core long-distance business. Still, the cuts were lighter than observers expected, and that is serving to focus investors' attention on the struggling telco's financial structure, credit rating and dividend plans.

Increasingly to some eyes, the company looks boxed in: Without any sure-fire sales boosters or white knights on the horizon, WorldCom will ultimately have no choice but to cut into muscle, analysts say. Compounding the uncertainty, WorldCom awaits the findings of an extensive

Securities and Exchange Commission

probe.

"Revenue growth is slowing dramatically due to lower demand and a brutally competitive environment," says UBS Warburg analyst John Hodulik. "At this point they have to make cuts to protect their earnings power."

The Choices

But the painful decisions won't be so simple, other telco watchers say. Some see a possibility that WorldCom could be forced to unwind its tracking stock structure; its

MCI

(MCIT)

unit currently pays holders a 60-cent quarterly dividend.

For its part, WorldCom says it has no plans to cut more staff and hasn't changed its $5 billion capital spending target. A spokeswoman declined to comment about the company's capital structure, in which its WCOM and MCIT tracking stocks represent business and consumer operations, respectively.

Shrinking Violet
Red ink punishes WorldCom

Bulls have argued that Wednesday's cost-cutting merely reflects a coming to terms with a long string of bad quarters, dating back years. But the credibility of that assertion has weakened in recent days as once-bullish analysts dropped their ratings amid continuing signs that WorldCom's business is still deteriorating. In its two-paragraph layoff announcement Wednesday, WorldCom said its cuts reflect lowered financial projections for 2002.

Particularly troubling are continued declines in WorldCom's vaunted business communications services. While the consumer side of the business has been ransacked by price competition -- particularly as people opt for free long distance in their wireless service plans -- it was long believed that sales of data and phone services to business customers would help offset that trend.

But business services revenue, which fell 1% last year, are not expected to have reversed that decline in the first quarter, say analysts.

New Wave?

Warburg's Hodulik, whose firm has no underwriting ties to WorldCom, cut his rating to hold from buy last week, making him the first Wall Street analyst to downgrade the stock. Wednesday morning, Lehman Brothers analyst Blake Bath became the latest to lower the boom, downgrading WorldCom to neutral from strong buy on similar concerns of a worsening sales outlook. WorldCom shares, which have plunged over the last year as the company's revenue and profits eroded, fell 3% to $6.60 Wednesday.

WorldCom got itself into a sticky situation with the creation of its tracking stock for business and consumer units, observers say. Analysts expect WorldCom will have to eliminate its dividend for the MCIT shareholders in an effort to save cash. WorldCom says it has enough money to fund the dividend through the end of the year.

But "reducing the dividend payout would be a positive and could help them conserve cash," as Standard & Poor's credit analyst Rosemarie Kalinowski points out. Both S&P and Moody's have a negative outlook on WorldCom credit, meaning a downgrade is a possibility. As of the end of last year, WorldCom had $32 billion in debt and $1.4 billion in cash. S&P rates WorldCom triple-B-plus, three notches above junk status.

The tracking stock was created to separate the deteriorating financial performance of the consumer unit from the business unit. It was also suppose to help highlight the attractiveness of the business unit to would-be acquirers. Clearly, the value of that separation is in doubt. Were WorldCom to fold both tickers back in, it would have to shell out a 10% premium to MCIT shareholders.

WorldCom still has plenty of options, analysts note. But increasingly, those remedies are exacting higher tolls.