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White Paper - Telecommunications Management Triage - Responding to WorldCom's Precipitous Financial Position

Date: Jul 01, 2002


Keller and Heckman LLP represents enterprise customers in negotiating telecommunications and networking services agreements with major interexchange carriers, including WorldCom. We also represent parties before the Federal Communications Commission on matters that directly and indirectly affect the procurement and pricing of telecommunications services. This White Paper is intended for WorldCom enterprise customers. It provides a perspective on the near-term consequences stemming from WorldCom's weakened financial position and suggests strategies for dealing with those consequences. This White Paper is not intended nor offered as legal advice.

Introduction

On June 25, 2002, WorldCom disclosed that it will restate its financial statements for 2001 and the 1st Quarter of 2002 for improperly capitalizing "line cost expenses" in excess of $3.8 billion.[2] This disclosure roiled the financial markets, evoked increasingly strident calls from Congress and the Administration for reform in accounting standards and corporate governance, and may well undermine the viability of WorldCom.[3] Putting aside--for purposes of this White Paper--the potential impact on UUNet and its Internet Backbone, and acknowledging the overwhelming shock to the company's employees,[4] WorldCom's enterprise customers may be the most adversely affected by the carrier's weakened financial position.

Possible Consequences Resulting From WorldCom's Recently Disclosed Accounting Impropriety.

For the immediate future, WorldCom likely will not be successful in either retaining existing business customers beyond the term of current multi-year agreements or in securing new enterprise customers. The nature of the disclosure and the adverse impact on the company's stock will most likely discourage prospective customers from entering into agreements to purchase services from WorldCom. Existing customers will be hard-pressed to agree to extend agreements (other than on a month-to-month or some other short-term basis) or enter into new multi-year agreements until WorldCom demonstrates that it has stabilized its financial position. Thus, WorldCom's revenues from enterprise customers likely will decline over the near-term. We cannot project the impact of such revenue reductions on WorldCom's overall finances.

Unless WorldCom seeks protection under the bankruptcy laws, it is unlikely that another telecommunications carrier or other entity will acquire WorldCom due to its high level of debt. The assets of many failed start-up telecommunications companies have more often than not been acquired at substantial discounts after the start-ups filed for protection under the bankruptcy laws. Few, if any, companies acquiring the failed businesses assumed the failed company's debts. The telecommunications carriers that acquired the assets of these failed start-ups are among the most likely candidates to acquire WorldCom or substantial portions thereof. We do not believe that even the largest telecommunications carriers, domestic or foreign, would acquire WorldCom and assume WorldCom's corporate debt that currently exceeds $30 billion.[5]

An Emerging View Suggests WorldCom's Network Services Will Be Maintained. Unlike the many failed telecommunications start-ups and other corporate debacles, WorldCom has substantial assets, know-how, revenues and businesses. A number of commentators suggest that because it is a principal supplier of telecommunications services to the Federal Government and the NASDAQ stock exchange, among others, the WorldCom network will not be allowed to go dark. Similarly, parties note the role of WorldCom's subsidiary UUNet as operator of the largest segment of the Internet Backbone.

A related view is that WorldCom's creditors do not want to place it into bankruptcy—and thereby lose their substantial investments. It is now being suggested that as a condition for making additional financing available, the financial institutions extending credit will require WorldCom to make substantially greater reductions in its workforce (in addition to the recent, widely-publicized 17,000 employee lay-off) and take other steps to reduce expenses.

Customer' Assessment And Tolerance For Risk Varies -- But The Need The Need To Plan Is Constant

It is impossible to predict whether or when a carrier's financial problems will begin to affect the carrier's services. When the carrier is a pre-eminent telecommunications carrier and your enterprise is dependent on the carrier's services, this unfortunate possibility must be assessed. For some, the risks may be perceived as manageable without the need for proactive steps. For others, the development of a contingency plan may be essential.

We believe it is unlikely that WorldCom's services will suddenly cease or degrade in the near future. Service problems likely would surface as chronic, progressively worsening performance in terms of trouble resolution, account support, and recurring failures to meet service level agreements ("SLAs"). This is the risk that we believe WorldCom's customers must assess.

A constant consideration in the development of any contingency plan is that a substantial amount of time (three to six months at best) is required to order services and/or plan the migration and cut over to a new carrier, particularly for data services and dedicated access services. Provisioning dedicated access services in the United States is also increasingly problematic from a timing perspective. The lead time to convert to alternate services can be even longer for the "foreign end" of international data services and in circumstances where the customer is obtaining managed services as well as transport services.

Recommendations For Current WorldCom Customers

1. Review Your Inventory of Circuits, Services and Customer Locations. As with the preparation of an RFP, an enterprise must know its current inventory of services and requirements.

2. Determine Your Current Telecommunications Services Commitments. Multi-year service agreements vary significantly with regard to the number of years, usage commitments, and other minimum expenditure obligations. Typically, an annual minimum revenue commitment is part of the agreement. We recommend that enterprises review their telecommunications agreement(s) with WorldCom and agreements with other telecommunications carriers, excluding the local exchange services provided by incumbent local exchange carriers.

This exercise provides a snapshot of overall expenditures, what an enterprise is contractually obligated to spend with WorldCom and for how long, and provides the basis for determining how much traffic (at various points in time) can be migrated to alternate service providers without incurring penalties.

It also provides a basis for calculating an enterprise's early termination liability (at various points in time), the formula for which is typically set out in detail in the WorldCom agreement.

3. Review the Grounds for Termination Without Liability in the WorldCom Agreement. This is basic due diligence. In all likelihood there is some version of an "insolvency clause" that provides the customer the right to terminate without liability in the event the carrier files for bankruptcy or otherwise makes a general assignment for the benefit of its creditors. There may also be service-quality bases for termination of one or more services or the entire agreement. In addition, the agreement typically provides a right to terminate for "cause" upon a specified notice period and opportunity to cure.

"Insolvency clauses" are often overridden by the trustee in bankruptcy proceedings. Enterprise customers may wish to consult with bankruptcy counsel to confirm the utility or lack thereof of the "insolvency clause" in their agreement.

4. Initiate Discussions with Alternate Carriers. At a minimum, it is a time to explore options. The time and resources to execute a transition of substantial volumes of traffic from one carrier to another and to negotiate an agreement that provides some semblance of reasonable rates can be significant. Customers that have implemented a "dual carrier strategy" are better positioned to deal with one carrier's service problems.

One approach is to negotiate a "contingent agreement" with another carrier that positions an alternate carrier to affect a customer transition on the shortest possible notice, but at a cost substantially less than the current fixed recurring charges incurred under the WorldCom agreement.

At a minimum, a "contingent agreement" would include dedicated access service arrangements at major enterprise locations. These services may have to be ordered, provisioned and tested by the alternate carrier. Also, modest levels of traffic may have to be committed.

5. Stay Informed. Remain in contact with your WorldCom account team. We believe WorldCom will communicate regularly with their valued customers. Stay abreast of the financial and related news and developments. Consult multiple sources of information for a complete picture of events.[6]



[1] For further information please contact, C. Douglas Jarrett at 202-434-4180 or by e-mail at jarrett@khlaw.com.

[2] WorldCom Press Release, June 25, 2002, http://www.worldcom/about_the_company/press_releases/display.phtml?cr/20020625 (last reviewed June 28, 2002).

[3] Jared Sandberg, Deborah Solomon, and Rebecca Blumenstein, "Inside WorldCom's Unearthing of a Vast Accounting Scandal," Wall St. J., June 27, 2002, at A.1.

[4] Unlike many telecom start-ups that experienced financial difficulties and have been forced into bankruptcy, WorldCom achieved long-term substantial cash-flows and real customer and traffic growth, and operates networks widely used by residential, governmental and enterprise customers.

[5] According to The Wall Street Journal, WorldCom's corporate debt includes approximately $30 billion in corporate bonds and a $2.65 billion bank loan. Mitchell Pacelle and Carick Molllenkamp, If Banks Call in Loan Now, Forcing Bankruptcy Filing, $30 Billion in Bonds Default, Wall St. J., June 27, 2002, at A3.

[6] Keller and Heckman LLP will be following developments and talking to various persons in the industry in coming weeks. As part of our longstanding commitment to enterprise customers, we will continue to respond on a courtesy basis to inquiries regarding WorldCom.