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Sprint Nextel Corporation (S), Verizon Communications Inc. (VZ): The $100 Billion Bankruptcy

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Sprint Nextel CorporationOn this day in economic and business history …

On July 21, 2002, WorldCom declared what was at the time the largest bankruptcy in American history, with $107 billion in recorded assets. The story of one of the largest telecom companies in the United States thus drew to a disgraceful close. That story, as is often the case with monstrous bankruptcies, is riddled with scandal, fraud, and executives desperately trying to maintain their weakening grasp on great wealth and power. Let’s get started with the early years, as the Daniels Fund Ethics Initiative explores WorldCom’s rise:

The story of WorldCom began in 1983 when businessmen Murray Waldron and William Rector sketched out a plan to create a long-distance telephone service provider on a napkin in a coffee shop in Hattiesburg, Miss. Their new company, Long Distance Discount Service (LDDS), began operating as a long distance reseller in 1984. Early investor Bernard Ebbers was named CEO the following year. Through acquisitions and mergers, LDDS grew quickly over the next 15 years. The company changed its name to WorldCom, achieved a worldwide presence, acquired telecommunications giant MCI, and eventually expanded beyond long distance service to offer the whole range of telecommunications services. WorldCom became the second-largest long-distance telephone company in America, and the firm seemed poised to become one of the largest telecommunications corporations in the world.

It’s an inspiring story, but what happened? WorldCom’s spectacular rise, particularly during the 1990s during the dot-com bubble, was largely fueled by acquisition. Between 1991 and 1997, WorldCom acquired dozens of companies for a cumulative $60 billion, which resulted in $41 billion in debt.

WorldCom’s $37 billion MCI acquisition, made public at the end of 1997, capped off this merger mania in an all-stock transaction that was then the largest corporate combination in American history. It also brought new problems for WorldCom — combining large companies successfully is a difficult process, and it can easily be bungled if executives lack the will or the capacity to manage the melding of two corporate cultures into one coherent business. WorldCom CEO Bernie Ebbers was not the man to manage that merger. He was busy leveraging his WorldCom stock, which would make him a billionaire within two years, to finance other business interests as diverse as a lumber mill, a Louisiana rice farm, a luxury yacht company, and a minor-league hockey team.

WorldCom had massaged the accounting of its many acquisitions to show more profit growth than was actually taking place. A rising stock price greased the gears of this acquisition merry-go-round, allowing WorldCom to purchase more companies, massage more earnings, and continue presenting the investing world with a picture of consistent momentum. A planned $129 billion buyout of what is now Sprint Nextel Corporation (NYSE:S) that would have created the largest telecom company in America was scrapped because of regulatory opposition. Shortly thereafter, the dot-com bubble burst, and WorldCom’s shares fell along with all the others, damaging its chances of securing that next big deal. Its merry-go-round of profit growth had finally stopped — and lacking a mobile business, WorldCom was ill prepared for the shift away from landlines that was already under way.

The fall of WorldCom’s stock price also caused problems for Bernie Ebbers, whose WorldCom shares were often used as leverage to purchase more WorldCom shares, creating a potentially devastating chain of margin calls. Ebbers pressured WorldCom’s board to loan him $408 million at below-market rates, to cover his margin calls and avoid the damage a major stock sale by the company’s CEO would do to WorldCom’s share price and reputation. They didn’t consider the possibility that WorldCom accountants, under Ebbers’ direction, had been cooking the books to create a far more damaging situation.

Beginning with the 1999 fiscal year, WorldCom executives began using more aggressive accounting shenanigans, to maintain a picture of business growth and thus to prop up its stock price. In the three years before its bankruptcy, WorldCom overstated its income by $9 billion and also manipulated its cash flows by misreporting $3.8 billion in capital expenditures in 2001 and 2002.

A small group of WorldCom employees, led by internal auditor Cynthia Cooper, became whistleblowers after discovering a number of irregularities on WorldCom’s books. This was not long after Enron’s bankruptcy shone a harsh light on WorldCom (and Enron) accounting firm Arthur Andersen, and Cooper’s team was not particularly willing to take that firm’s assertions at face value. Shortly after Cooper exposed the problem to WorldCom’s board, Ebbers resigned, and Arthur Andersen was convicted of obstructing justice in the Enron case. WorldCom, unable to hide the truth, announced its intention to make a major restatement of earnings on June 25, 2002, and the SEC filed charges against WorldCom the following day. Cooper later became one of Time‘s three People of the Year in an issue celebrating “the whistleblowers.”

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