The Walls Come Tumbling Down

Posted: 08/2002

The Walls Come Tumbling Down
Carriers, Channels Caught in WorldCom Fallout

By Josh Long

Z-TEL TECHNOLOGIES INC. WAS PLAYING with a full house early this summer. It had won a sweet contract -- $50 million in licensing plus per-line fees -- with WorldCom's MCI Group to provide American households local and long-distance services through a package dubbed "The Neighborhood." Z-Tel provides local voice services for the plan in 23 states through a UNE-P. MCI Neighborhood was a hit, acquiring more than 400,000 customers on Z-Tel's network as of July 1. Partly because of the deal, Z-Tel expected to reach EBITDA positive for the second quarter.

Z-Tel's plan -- to focus more on its wholesale services and less on its retail residential offer, which was suffering flat growth and increasing bad debt -- was coming along nicely. It all changed June 25. That's when WorldCom disclosed it had misreported $3.85 billion in earnings, igniting a storm of federal probes that could knock the company into bankruptcy court and some of its high-profile executives behind bars. Together, MCI and WorldCom make up the No. 2 long-distance carrier.

Z-Tel executives said in a prepared release that they do not expect WorldCom's troubles to "have a material effect" on their ability to meet profitability goals. Z-Tel is in talks with other carriers to forge similar wholesale agreements, a spokeswoman said. "While MCI ... certainly has started to become an increasing contributor to our revenue stream, the lion's share of revenue continues to come from [the] residential retail business," she said.

Trickle Down Effect

Clearly, the corporate calamity has sullied the MCI brand, threatening growth projections for Z-Tel, one provider among many telecom companies around the world impacted by WorldCom's woes.

"Every company -- whether IT, IP, telecom vendor, carrier, ISP or application provider -- is affected by the demise of what was once one of the most powerful global telecom companies in the world," notes Allan Tumolillo, COO of Probe Research Inc.

WorldCom, the world's largest Internet backbone company, is one of the central arteries of the global telecommunications network. It operates 30 percent of the bandwidth on the 20 largest U.S. Internet backbone routes, TeleGeography Inc. reports (see sidebar on page 16).

Aside from its millions of retail customers -- including many Fortune 500 and multinational corporations -- WorldCom's elaborate chain of wholesale customers, brokers and suppliers includes government-controlled incumbent telephone companies throughout the world, U.S. telephone, data and Internet providers and independent sales organizations. (The MCI Group's 2001 Annual Report states this unit serves 470 carriers and resellers.)

With 17,000 employees receiving pink slips and reports as of July 19 that a chapter 11 bankruptcy filing was likely, WorldCom soon may lack the manpower and autonomy to adequately support its global infrastructure and the throng of communications companies that rely upon it, say observers, including Tom Evslin, CEO of ITXC Corp., an international wholesaler that has reciprocal agreements with WorldCom.

Evslin says providers having reciprocal agreements with a company on the verge of a bankruptcy likely will have many questions. Will I get paid? Do I want to keep selling to that company? When will they file? What will I do post bankruptcy?

One immediate response: Multiple carriers holding bilateral agreements have sent over a flood of traffic to embattled providers in order to hedge their financial exposure, Evslin says. "You try all of a sudden to get back in balance as quickly as you can."

By inflating the amount of traffic routed to WorldCom, a carrier may try to avoid being owed money by the carrier at settlement time. Should WorldCom file bankruptcy, the creditor may have no recourse to collect on such a bill under U.S. bankruptcy laws.

But there is a point in which quality suffers -- calls might be dropped -- on a taxed network, Evslin explains. In the prebankruptcy days of some carriers ITXC has dealt with, the quality "would go straight off a cliff," he says.

Another risk in using this method to protect against bad debt is that carriers likely are increasing their cost structures. A carrier sending WorldCom double or triple the normal traffic volumes probably gets a better rate on at least some of those routes from other providers.

As a result of Worlcom's and other carriers' financial straits, Arbinet-thexchange president and CEO Curt Hockemeier says he expects carriers to tighten their credit restrictions to prevent bad debt, including demands that companies pay their bills in a shorter-time period. The potential result is that some providers may be stuck paying higher wholesale prices to a carrier rather than the exchange, for example, where the credit terms are stringent, he says.

And says Brent Wilkins, managing director of telecom broker Cantor Telecom, "I think it is going to change the way companies look at contracts whereas 18 months ago it was all about price."

He says that he expects carriers will seek to restructure reciprocal contracts based on flexibilility rather than price alone. Wilkins envisions carriers charging a premium for a standardized short-term contract that would offer communications companies the flexibilitity to tap various networks based on many factors, including performance and the financial viability of their supplier.

Long-haul providers aren't the only ones worried about being on the hook to WorldCom. Local telephone companies that collect fees from other service providers to originate and terminate phone calls have amassed delinquent receivables on their books after beleaguered carriers filed for bankruptcy protection.

The financial ramifications would be 100-fold if the No. 2 long-distance carrier didn't pay CLECs for carrier access charges, says Arunas Chesonis, CEO of PaeTec Communications Inc. "I don't think it will get to that point but it depends who is running the show. Not knowing is worse than knowing."

Ready to Pounce

It is the ambiguity surrounding WorldCom that has put Sprint Corp.'s wholesale team in a better position to garner new accounts from large carriers to smaller resellers.

"The last week has been very interesting to say the least," Sprint vice president of wholesale service Art MacDowell said following WorldCom's disclosure. "We have seen some significant activity. We have started to get a lot more interest from carriers we have not been that close to."

During the week after the announcement, Sprint account managers spent most of their days talking to prospective customers. MacDowell says large carriers already have several layers of network redundancy, but smaller resellers may have a greater sense of urgency to ensure a backup plan. Moreover, even if WorldCom's network remains operational, "it doesn't mean you are going to get the same level of service you are used to," he said.

How much of WorldCom's carrier business could be up for grabs? Perhaps 25 percent, MacDowell guesses.

Atlantic-ACM analyst Nick Regas reckons WorldCom will not lose a torrent of wholesale traffic. He cites the example of Global Crossing Ltd., a carrier that has managed to retain many of its wholesale customers despite filing in late January one of the largest bankruptcies in U.S. history, listing $12 billion in debt.

"I would hypothesize the same thing will happen with WorldCom and their wholesale division," Regas says. "There won't be a dramatic shakeup in the wholesale industry."

Other large carriers were mum on their relationship with WorldCom and to what extent their wholesale sales departments were gaining momentum as a result of the crisis. AT&T Corp. and Qwest Communications International Inc. declined to comment, and Level 3 Communications Inc. did not return calls as of presstime.

A spokeswoman for bankrupt wholesale carrier Williams Communications Inc. says the company has a long-standing relationship with WorldCom, which has offices in Tulsa, Okla., where Williams is based. Williams has not taken any action regarding WorldCom, she says.

During a July 2 press conference, WorldCom CEO John Sidgmore told reporters in response to a question about what the company is doing to prevent its resellers and agents from taking business elsewhere that executives were working with customers, employees and channels to restore confidence. He said he and new COO Ronald Beaumont had been making calls personally.

Environment of Fear

Reseller CIMCO Communications Inc., a large telephone and data provider using the WorldCom network (among other networks) to serve business customers predominantly in the Midwest, has seen few customers requesting to get off the WorldCom network, says CEO Bill Capraro Jr. Capraro says perhaps 10 percent of his business customers using WorldCom's network have asked to switch carriers. Cimco nearly always deploys redundant networks and is staying with WorldCom for the time being, he adds. "The vast majority have faith and understanding we are looking out on their behalf and if we see any service interruption in the horizon we will make the switch for them."

Nevertheless, WorldCom's situation is creating fear throughout the industry, including with the community WorldCom relies heavily upon to fuel new growth: independent sales organizations.

Some sales agencies tell PHONE+ the carrier's disclosure makes it difficult to sell the WorldCom name. Many pending business contracts were canceled following the news, agents say. "The immediate reaction we had [was] 60 percent of WorldCom's orders in process canceled as of today," says the president of a master agency, "The reaction is 'Get me out of here fast.'" Other sales representatives report similar experience.

Still, large master agencies representing the country's largest carriers say it is virtually impossible to believe WorldCom would shut down major parts of its network in a doomsday scenario. "They are so deeply imbedded as a broadband provider in the retail, wholesale and government space that it is practically unrealistic to think they could disappear as an entity," says Ted Schuman, CEO of Scottsdale, Ariz.-based PlanetOne/US Telebrokers.

Schuman says a reliable senior level manager told him the alternate channel unit is profitable and that he expected the layoffs to have "little to no" effect on WorldCom's agent program. WorldCom management expects the alternate channel program to "remain 100 percent intact," Schuman says, quoting the manager.

This attention may have a positive effect, but agents remain leary. Founding partner of Denver-based channel development consultant and master agent Market Race LLC, Nik Nesbitt says, "I think agents are a resilient lot and this will cause them to be even more cautious as to who they sign up with."

And Rick Dellar, co-owner of Petaluma, Calif.-based master agency Intelisys, implores sales organizations to act responsibly during WorldCom's crisis and to refrain from leveraging scare tactics to score a quick paycheck, a tactic the 10-year industry veteran says he has witnessed.

"It's an environment of fear right now. The fact is no one is going to shut off WorldCom's telecom circuits," he says. "Being in the agent community I think it is real imprudent, for personal gain, to try to scare people into making a change. WorldCom has created its own mess and if they lose customers they will deserve to lose those customers."

Dellar suggests agencies serve as an educational guide to companies and cultivate a relationship of trust that will prove fruitful when new business opportunities arise. In practice, though, businesses already are seeking alternatives to WorldCom, including those that normally shun cold calls, some agents say.

The comptroller of a construction company recently told sales agency Customer Service Telecom the only reason he picked up the phone was because of what he described as "WorldCom's woes," says Steve Fair, president of Customer Service Telecom. Fair says his sales representative did not even know whether the company used WorldCom for local service. The customer feared he would come in one day and not have local dial tone, Fair says.

Despite the widespread view that it is highly unlikely WorldCom would shut down vital parts of its infrastructure, some agents say businesses are seeking alternatives for reasons other than fear of a network failure or shutdown. Says Fair: "When a company says we lost a $1 billion that is not news. But when you are involved in fraud ... companies don't like that actually."

Agents who represent WorldCom say they are concerned about future commissions, particularly if the carrier files a Chapter 11 bankruptcy petition. Several financially troubled competitive carriers, among them Global Crossing, listed agents as unsecured creditors rather than as employees. Bankrupt carriers owe independent sales representatives anywhere from a few hundred dollars to hundreds of thousands of dollars, master agencies say. Some agents are not likely to recover a dime, particularly if they are listed as unsecured creditors and the bankrupt provider has liquidated the company.

Fred Newman, president of New York-based sales agency Wintel Communications, says he is worried about his future revenue stream from WorldCom. But, he adds, "we are not going to attempt to relocate customers unless the carrier tells us they are going out of business and it's a free-for-all."

WorldCom is simply too huge of a company to disappear, he and other agencies reiterated. The federal government and business community simply wouldn't let the network go dark. But one thing is clear: American businesses are wary of the telecom titan, and agents' options of viable -- and venerable -- carriers continue to diminish.

Says one agent: "New customers come to us and say anything but WorldCom."

Aberdeen Group industry analyst Dana Tardelli adds that although AT&T and Sprint likely will win departing WorldCom customers, the whole industry loses. "With the ongoing demise of telco competitors, the market will have less reason to innovate," Tardelli says. "The market will also have to endure a glut of fire-sale assets and a ripple effect that will carry over to the telecom equipment markets. Meanwhile, a telecom recovery becomes even less likely in the next two to three years."

WorldCom Stock's Slippery Slope
Source: Commodity Systems Inc.

--Additional reporting by Khali Henderson