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WorldCom – from Telecom Giant to $11 Billion Accounting Fraud

WorldCom was destined to be part of the new generation of telecoms that dominate the U.S. Companies like Verizon, T-Mobile and Qualcomm, giants that to this day appear on the watch lists of stock traders.

So what happened to a company that had a market cap of over $175 billion at its peak? How could something so big actually go bankrupt?

From $175 billion to zero

The root cause of the scandal was CEO Bernie Ebbers, a cowboy in appearance and demeanor, who had built WorldCom to be the second largest phone company in the 1990s with a series of acquisitions and aggressive mergers. Most of them funded by the belief the stock price would continue rising to supply the cash needed for a continued expansion.

WorldCom - from Telecom Giant to Accounting Fraud 2

Riding the wave of the Internet revolution and the accompanying climb of the stock markets, WorldCom acquired MCI Communication in 1998, another telecom company that actually had over 2.5 times the revenue of its buyer!

Ebbers was driven by the belief that he always had to appear on the offensive, always increasing revenue for the company and always gaining more personal wealth.

But there was one factor he failed to predict, or at least its timing. The first signs of the Dotcom bubble were starting to show in 1998 and income streams started to shrink for telecoms, who had bet on constant exponential growth for the early internet companies.

Additionally all the acquisitions were taking some time to gel properly and provide the naturally expected growth. So Ebbers became aggressive in his trading pursuits and after hitting several margin calls, was forced to borrow $400 million from Bank of America to cover them. In the process he lost a vast part of his WorldCom shares which were used as collateral.

To hide his own personal financial problems and those of the company’s shrinking growth, Ebbers orchestrated the classifying of expenses as profits.

At the same time the stock market was crashing, WorldCom reported profits of $3 billion in 2001 and another $800 million at the start of 2002. What should have been an annual and Q1 loss was actually reported as another profitable period.

Later it was revealed that the full amount of the made up assets was $11 billion.

WorldCom ‘s Fall From Grace

But it was these profits, the unfolding of the Enron scandal and the failed merger with Sprint, that prompted investors and authorities to look closer at what was going on in WorldCom.

Memos from some executives at the company to the auditors at Arthur Andersen (the same auditor Enron had) revealed that they were warning about the inflated profits, part of an unsustainable lie. At some point the company had to pay dividends and salaries and it would be revealed that there’s nothing to spend.

That point came at July 21, 2002 when the company filed its bankruptcy documents. Bernie Ebbers received a 25-year sentence after CFO Scott Sullivan testified against him. 30,000 jobs were lost and a total of $180 billion of losses hit investors.

After restructuring the company, splitting the stock, paying off settlements and straightening the books, the last acquisition – MCI – emerged from the ashes and became the foundation of a new company that became a subsidiary of Verizon in 2006.

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