It's hotter than the Fourth of July for telco investors.
Beleaguered shareholders in troubled telcos
braced for more bad news Friday, amid reports that the companies now face criminal investigations for potential accounting violations. Both companies have already been named in a range of regulatory probes.
Qwest, the Denver phone giant, denied a
Wall Street Journal
report Friday that it is the subject of an investigation by the Justice Department. Meanwhile, WorldCom's efforts to dig into its own books apparently stalled out, as Justice officials said they'd prefer to handle the inquiry first, according to the
The prospect of criminal proceedings weren't the only worry for telecom investors Friday. As Wall Street continues to wonder how long debt-burdened WorldCom can continue to operate without undergoing a massive restructuring, reports had the company's bondholders considering a debt-for-equity swap that would essentially wipe out current shareholders.
Friday's events mark the latest chapter in the quickly unraveling story of a pair of onetime highfliers of the telecommunications world. WorldCom shares now trade for pennies in the wake of a series of revelations culminating with the late June disclosure that the company had massively overstated its earnings over the last year. Qwest shares have also dropped more than 90% since their late 2000 peak as the company faces an avalanche of inquiries and shareholder lawsuits linked to its bubble-era business and accounting practices.
Though WorldCom has fairly grabbed the headlines over the last week and a half with the staggering scope of its accounting irregularities, Wall Street has hardly forgotten about Qwest. The company's shares have plunged into the $1 range as speculation rages that Qwest will be the next household name in the telecom world to be consumed by accounting scandals. The company has long said its practices are proper, but many analysts and investors have said Qwest's bookkeeping was among the most aggressive of a notoriously growth-minded lot during the Internet building boom.
Indeed, Qwest is already under two separate
Securities and Exchange Commission
investigations into accounting practices. One focuses on its use of pro forma earnings statements and its handling of expense data in its 2000 financial reports. The company failed to offer investors full financial data according to generally accepted accounting principles, regulators have said.
The second investigation centers on the accounting treatment and underlying value of network capacity sales with other telcos. In particular, investigators are probing "swap" transactions like a controversial
11th-hour deal between Qwest and Enron last fall, in which each company booked $112 million in revenue. Investors have increasingly come to doubt the underlying business value of such deals, which is leading some observers to question revenue associated with these agreements.
The SEC has shown particular interest in the Enron swap, people close to the probe say. Notably, that transaction was booked on the last day of the quarter, which to some observers suggests desperation on the part of the companies involved. Some analysts note the higher-than-normal margins on these capacity sales may have helped Qwest stay in compliance with its cash-flow-to-debt-ratio covenants.
WorldCom ignited a frenzy of inquiries last week when it admitted to fudging $3.8 billion in expenses, boosting earnings for the previous five quarters. While new CEO John Sidgmore has attempted to distance his new administration from the matter, he is likely to face an intense grilling Monday on the floor of Congress.
Some observers question the timing of the internal audit, which uncovered the massive irregularity, and the
sudden decision by WorldCom to draw down its $2.65 billion credit line. Access to that cash may have been impossible if the banks had caught wind of the impending discrepancy.
And as one analyst pointed out, expense accounting is only one element that has been exposed so for. The SEC has a 24-point investigation underway that ranges from customer billing practices to all documents relating to the estimated $15 billion to $20 billion goodwill writedown planned for this year.
"This is far from over," the analyst said.