Worldcom Inc. – Corporate Bond Issuance

FINC 621 – Corporate Finance Case Presentation Assignment – WorldCom Inc – Corporate Bond Issuance

Alison  

Assignment

1. The Telecomm Act of 1996 opened up the long distance telephone business to competition, numerous companies entered the market to offer services. WorldCom kept expanding its business by acquisition. WorldCom had grown through 50-odd acquisitions since 1992 and turned into one of the most famous telecom companies in the United States.

From the perspective of the business organization, the Telecomm Act of 1996 created convergence and unparalleled demand in the telecom industry. WorldCom was no longer a regional long distance reseller but became a facilities-base service provider. The acquisition of MCI helped WorldCom reach 25% share in the U.S. long distance market and obtain end-to-end ownership of the network. It had to issue a lot of bonds to raise funds in the market.  

From the perspective of management, WorldCom lacked core value in the business and was overoptimistic on the whole industry, forgetting about the development of new product and service. The CEO, Bernie Ebbers, is more like a deal-maker. Ebbers wanted to be successful in the stock market but not to build an innovative telecom company. Following the acquisition, Ebbers “shaped up” the culture of MCI. However, the turnover rate was high inside of the company (70% of MCI executives left), and the whole business strategy changed from product innovation and brand building to profit return.

From the perspective of risk control, WorldCom was overconfident. The intense competition brought pricing constraints. Next, the aggressive expansion plan caused a great amount of bond issued in the market. The large amount bonds in once were too risky for the company. The cost of interest was very high. In the mean time, the entertainment boom and the internet business did not keep up as expected. WorldCom developed aggressively in fiber-optic cable based on its post projection. However, wireless service was increasingly used by the market. Once the company operates badly, it leads the company to failure.

2.A series of financial crisis and politic issues, U.S. capital market had a lot of stresses at that time. Dow Jones Industrial Average dropped 300 points, which was the third-largest percentage loss in Dow history. The money left the stock market and flew into the corporate and treasury securities.

Exhibit6 shows slight change in the short-term treasury and corporate bonds rate. If everyone rushes to buy a corporate bond and treasury securities, the potential revenue will decrease. However, the market preference didn’t affect interest rates. Historic yields showed the Baa-rated corporate’s yields were higher than those of U.S. treasury over 10-year composite rate, which means the corporate bond had a higher return. The spread of Baa-rate US 10 years’ composite rate was between 1.1 and 1.41, which is a somewhat bit risky.

There are $475.5 billion investment-grade issues in the second half of 1997, which is almost twice than that of the first half of 1997 ($246 billion). High-yield issues $99.8 billion in the first half of 1998, which is a large increase compared to that of 1997.

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The increase rate of high-yield was higher than that of common stock. High debts bought risky to the company. The cost of corporate debt of was too high.

3.Bond ratings agencies are those companies which assess the creditworthiness of both debt securities and their issuers. It helps to regulate the financial market and estimates the risk premiums. It can also enhance the transparency in the financial market and standardize the evaluation process. A good rating can reduce the capital acquisition cost.

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In that time, WorldCom was rated Baa2 by Moody’s Investors Service.

According to WorldCom’s financial information. It’s operation income and net income fluctuates a lot which has potential risk to the company. In 1997, the operation interest coverage ratio is 3.4, which means the operation income can cover the interest expense. According to Moody’s Bond Rating definitions, the A class company’s interest payments are protected by a large or by an exceptionally stable margin and principal is secure.

The long-term debt increases 1,723,636,000 dollars in just one year. And the long-term debt grows faster than the shareholder’s equity. The debt-total assets ratio increase shows the business is risky at that time. At the mean time, the current ratio is lower than brings means there is the risk in short-term liquidity. However, WorldCom didn’t have the fatal problem at that time. So it’s reasonable to rate WorldCom in group B. In my point of view, I think it was overrated a little bit.

Moody assigned Aaa rating to Microsoft's proposed debt issuance in 2015.[pic 3]

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Microsoft’s interest payments are protected by a large or by an exceptionally stable margin and principal is secure.

Bonds that are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as “gilt edge.” Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. And the debt-equity ratio remains in a healthy situation and the gross margin and revenue keep increasing in a healthy way. At the meantime, the net income stays positive which carry the smallest degree of investment risk.