Description

WorldCom 8.25% notes due 5/15/31 ($40). WorldCom notes, trading at roughly 40% of par, offer an attractive investment opportunity. Since most people are fairly familiar with the telecommunication company, I won’t go into operational detail, but instead focus on the financials.

As of March 31, WorldCom – by WorldCom I mean the entire company including the MCI tracking operations had roughly $2 billion in cash and $30 billion in debt. Last year WorldCom generated $9.6 BB in EBDITA ($1.5 BB from MCI). This year, the current projections are for roughly $8 BB in consolidated EBDITA, including somewhat less than $1 BB from MCI.

WorldCom’s near term maturities trade at higher prices. Overall, the value of the company’s debt is about $15 billion, or less than 2x 2002 projected EBDITA, the bulk of which comes from the non-MCI businesses. There are two risks involved, liquidity problems and continued business deterioration. The near term liquidity risk is serious, but not critical. There are minimal maturities due for the rest of the year, $3 billion next year and $2.5 billion in 2004. In addition, WorldCom is in the process of renegotiating a working capital securitization facility that will essentially require $500 million in cash. The company has an unsecured $2.65 billion credit facility that it will draw down and is negotiating a $5 billion term credit facility, which will replace the $2.65 BB line. The banks will probably fund this agreement since it will be secured by PP&E. This would provide the company two years of breathing room.

New management is obviously focused upon improving the financial situation. Sidgmore plans a restructuring announcement this summer. The most likely actions include (i) further cuts in cap. exp., (ii) sale of ancillary wireless and some int’l operations – not much in net proceeds, but mostly cash flow negative, (iii) potentially a debt for equity swap or sizeable bond repurchase.

Even if liquidity problems force WorldCom into Chapter 11, the recovery rate on the notes should be substantially in excess of current prices. Before the current credit drawdown, WorldCom had no senior bank debt or commercial paper, so there is no subordination currently (Effectively the new term creditors will become senior because of their security, but this represents new money to the company). Current company cap exp plans are $5 billion this year, and will probably be reduced by at least another billion. Even assuming further significant business deterioration, WorldCom should generate $6 billion in EBDITA in 2003, with say $3 billion in cap exp, enough to justify an enterprise value of $20 billion on the restructured company.


Ultimately, the bull case rests upon a belief that industry conditions will stabilize. I think this is likely for two reasons. First, conditions in the core (non-MCI) business are not that horrible. Revenues were down only 2% y/y in Q1. Underlying demand for internet and data traffic will continue to grow. I believe that as consumer high speed penetration increases, we will see significant amounts of entertainment product sold over the net; these applications consume tremendous amounts of broadband capacity. The Ebbers problem has been resolved. The industry problems were a result of huge overbuilding facilitated by gullible financial markets, which are now closed to emergent telcos. There is unlikely to be any new telecom network construction for a long time, which will alleviate competitive pressures. Finally, more than one RBOC has stated a strategic interest in buying WorldCom. Based upon these numbers, an acquisition through a restructuring that paid 75 cents to the bondholders would be highly accretive.

The notes were issued as part of an $11 billion financing that WorldCom undertook only last year to repay its short-term borrowings. The sheer size of the offerings and rapid credit downgrade are the primary factors in the undervaluation of the securities. Most of the holders had restrictions that allowed them to hold only investment grade securities and hence were forced sellers. The junk bond community has had such a bad experience with telecom paper (and is so heavily exposed) that it has had limited buying interest. Distressed investors simply aren’t large enough to absorb the rest, hence the bargain prices.

Catalyst

(i) WorldCom successfully completes its negotiations for the $5 billion term loan.
(ii) Announcement of credible financial restructuring this summer.
(iii) Possible RBOC acquisition.