Description

In the bankrupt rubble of Worldcom, there is a $750 million preferred stock issue called the MCI QUIPS (Ticker: MCPEQ on the pink sheets). Yes, pink sheet equities in bankrupt companies are worthless 99.9% of the time. There are special features to the MCI QUIPS, however, and the MCI QUIPS are far from worthless. I believe the MCI QUIPS will recover an amount much closer to their par value of $25.00 per share than their current market price of $8.10.

MCI Communications Corporation was organized in 1968. It grew to become the second largest long distance carrier in the United States and produced about $4 billion of annual EBITDA by 1998.

In 1996, the MCI QUIPS were issued by an entity called MCI Capital I. MCI Capital I is a Delware trust that is wholly owned by MCI Communications Corporation. MCI Capital I issued $750 mil of preferred securities in the form of 8% Cumulative Quarterly Income Preferred Securities (hence the QUIPS name). MCI Capital I does not have any debt and has no other preferred stock besides the QUIPS. Therefore, the QUIPS effectively represent the highest priority claim on the assets of MCI Capital I.

What are the assets of MCI Capital I? MCI Capital I holds $750 million of 8% Junior Subordinated Deferrable Interest Debentures which were issued by MCI Communications Corporation in 1996. This is a typical “trust preferred” structure that allows the economic issuer (MCI Communications Corp in this case) to indirectly sell preferred stock to investors while getting a tax deduction on the associated interest expense that is paid to the trust. MCI Communications is the legal obligor on $750 mil of debt held by MCI Capital I, which the QUIPS effectively own.

Two years after the MCI QUIPS were created, MCI Communications Corporation was acquired by Worldcom, Inc. In the acquisition, MCI Communications Corporation was merged into a merger subsidiary of Worldcom and MCI became a wholly owned subsidiary of Worldcom. Post acquisition, the assets of MCI Communications remained owned by MCI and its operating subsidiaries. MCI Communications also continued to be the obligor on $2.59 billion of senior bonds that were issued prior to the merger and on the 8% Junior Subordinated Deferrable Interest Debentures held by MCI Capital I. While Worldcom began to present MCI’s assets on a combined basis with its own assets for accounting purposes after the merger, it’s important to note that MCI’s assets remained legally separate from Worldcom’s. The corporate structure left Worldcom as an equity holder of MCI, meaning that Worldcom bondholders (whose sole claims are at the parent company, Worldcom, as they do not have a guarantee from any of the subsidiaries) have no claim on MCI assets other than through Worldcom’s ownership of the MCI equity.

Four years after its acquisition of MCI, Worldcom revealed a multi-billion dollar accounting fraud. The fraud primarily involved improperly capitalized line costs during 2001 and 2002. This eventually led the company to file for bankruptcy in July 2002. On the petition date, Worldcom had consolidated debt of over $30 billion including unsecured bank debt and bonds issued by Worldcom, Inc. While this is a staggering amount of total debt that dwarfs the current value of the assets, we need to concern ourselves only with the size of the MCI claims and its assets.

Under the US bankruptcy code, senior claims of an entity must be paid in full before junior claims receive any recovery. In the case of MCI, the $2.59 billion of MCI bonds and the $750 mil of 8% Junior Subordinated Deferrable Interest Debentures must be fully satisfied before value from the MCI assets can be distributed via MCI’s equity to Worldcom bondholders. The monthly operating reports being filed with the bankruptcy court indicate that current EBITDA is approximately $4 billion per year. As debtors’ counsel has noted, substantially all of the cash flow generating assets are held by MCI and its subsidiaries. With $4 bil of EBITDA being produced by MCI assets, we can therefore be comfortable that the asset value of MCI is enough to satisfy all of the MCI claims and, therefore, the QUIPS claim at MCI Capital I as well. If the Worldcom bondholders expect any recovery (the current market value of the Worldcom bonds implies approximately a $6 bil recovery for them) from MCI’s assets, then those bondholders will have to confirm a plan of reorganization that either reinstates the MCI QUIPS or provides QUIPS holders with a full par recovery.

Catalyst

1. Filing of a plan of reorganization in mid 2003.
2. Gradual public realization of structural seniority of the MCI QUIPS to the Worldcom bonds.
3. Emergency from bankrutpcy
4. Elimination of view of QUIPS as a tainted security when it moves off the pink sheets.