MCI-Communications-Corp.--1983

MCICommunicationsCorp.CaseStudyJune7,2015Contributors:JeremyGlennonJustinHolmesYiboJiangShawnRichardsonEsmeraldaTarajBriefSummaryandSituationSummaryFormorethanadecade,MCIwascompetinghead-to-headwithagoliathmonopolisticcompany--itwasaDavidversusGoliathtypestory.MCIwasarapidlygrowingtelecommunicationscorporationbattlingAT&Tinthecourtsandinthebusinessworld.Theywentfromnothingtoanextremelyprofitablecompanyveryquickly,butin1983,afterananti-trustsettlementwasreachedbetweenAT&TandtheJusticeDepartment,thefuturebecameuncertain.HistoricallyAT&Twasbothacompetitorandanecessity,astheyleasedtheuseoftheirinfrastructuretoallowMCItoprovidetheircustomerswithservicesthattheycouldnotprovidewiththeirowninfrastructure.InFY1983,$137.2millionwaspaidbyMCIforuseoftheinfrastructure,butasettlementwasfinallyreachedbetweenAT&TandtheJusticeDepartmentthatseparatedAT&T’slongdistancedivisionfromitslocalservicedivisions,makingthelongdistancedivisionsindependentofthelongdistanceservice.Therefore,after1986(whenthistakeseffect),MCIwouldbeabletocompetefairlywiththenewAT&TCommunicationslongdistanceservice,whilebeingabletoprovidelocalphoneserviceonanequalcompetitivelevel.However,amajorproblem(asaresultofthissettlement)isthatthecostforMCIwouldimmediatelyincreasebecausetheywouldhavetopayforlocalservicesatthesamerateastheircompetitors.ThiseliminatesthecostadvantagesthatMCIwasabletoprovide.Inaddition,AT&Twouldnowbeallowedtodecreasetheirlongdistancepricestoallowthemtocompetitivelymaintainmarketshare.ThelossofsomecostadvantagesandtheabilityofAT&TtocompeteonthebasisofpricecreatedabigunknownforthefutureofMCI’srevenues,earnings,andasaresult,theabilitytoforecastworkingcapitalandcapitalexpenditures.In1983,MCIheld$550incashanditsstockpricewas$47.SituationTheentirehistoryofMCIhadbeenfinanciallytumultuous--goingfromabuddingnewcomer,acompanyintechnicaldefault,toaveryprofitablecompany.Managementhasusedmanydifferentmethodsoffinancingandfordifferentreasons.MCIhadbeenexperiencingrapidgrowth(fromalossof$38.7millioninFY1975toaprofitof$170.8millionin1983)becauseoftheabilitytoprovidelowerpricesforlongdistanceservices,butaftertheantitrustsettlementbetweenAT&TandtheU.S.DepartmentofJusticeinJanuary1982,itbecameunclearwhetherthisadvantagewouldbeabletocontinue.ThesettlementcalledforAT&Ttoplayonafairplayingfield,butontheotherhand,iteliminatedMCI’scostadvantagesrelatedtoitslong-distanceservicesandallowedAT&Ttocompetemoreflexibly.TherewasuncertaintyaboutwhetherMCIwillcontinuetorapidlygroworifthenewcompetitiveenvironmentthatresultedfromthesettlementwouldimpedegrowth.Now,MCIhaddifficultchoicesconcerninghowtocontinuetogrowunderthesecircumstancesandhowfinancingshouldbeaccomplished.Now,inApril1983theenvironmentfortelecommunicationswascharacterizedbyalargepotentialdemandforexternalfinancing,butsincethefutureforMCIwasuncertain,settingfinancialpolicywasdifficult.Withthatinmind,managementhastodecidehowtoproceedwhilemakingsurethatthesignalstheysendwon'tnegativelyimpactshareholders.Decisionsarenotonlyaboutgrowth,risks,andcapitalneeds,butalsoabouthowthesedecisionscancreatesignalingproblems,andtherisksandbenefitsthatthesesignalscancause.Weexaminethishere.HistoryofMCI’sFinancingAfterMCIwasorganizedtheyincurredenormousfixedcostsfromthegrowthoftheircommunicationsnetwork.Theywereastart-uptelecommunicationscompanywithlimitedcapitalandwerefundedprimarilythroughtheissuanceofcommonstock,acreditlinefromasyndicateheadedbytheFirstNationalBankofChicago,andthroughsubordinatednotesfromprivateinvestors.Until1986,theywillbedependentonAT&T’sfacilitiestohandletheirservicefromitssubscriberstoMCI’sservice.Duetothecostofthis,MCIwasn’tabletoinitiallygeneratesignificantsubscriberrevenuetojustifytheaccumulatedoperatingexpensesthataccompaniedtheirnewlybuiltandgrowingcommunicationsnetwork.Inaddition,asdescribedearlier,theywereintechnicaldefaultby1975.Then,in1976thecourtsdisallowedtheExecunetservicefornewcustomers,soitbecameverydifficulttoobtainfinancing.However,theystillneededtocontinueoperationsandgrow.Withthecourtorderrestrictinggrowthopportunitiesfornearlytwoyears,thattheExecunetserviceprovided,andwithMCInotleftwithmanyotherfinancingoptions,MCIutilizedleasefinancingonnewfixedinvestmentstoexpandcapacityintoMCI’sexistingmarkets.OverviewofFutureFinancingDecisionsIn1980,MCIbeganofferingitsextremelysuccessfulExecunetservicetoresidentialcustomers--itwaspreviouslyonlyavailabletobusinesses.ThisprovedextremelysuccessfulandresultedingrowthonlybeingconstrainedbytheabilityofMCItoraisecapital.Execunetwasdisallowedbythecourts,andthenallowedtocontinueafewyearslater;butwithExecunetservicesuspended,itwasdifficulttoobtainfinancing.OnceExecunetwasonceagainpermittedfornewcustomers,financingbecameavailableagain.Asaresult,in1982revenuesdoubleto$506millionandthendoubleagainin1983to$1,073million(withhelpfromtheacquisitionofWesternUnionInternationalfromXerox).Now,afterthesettlementwithAT&T,theabilitytocontinuetogrowandtoobtainfinancinghascomeintoquestionandfinancingdecisionandtheresultingreactiontothesedecisionsneededtobecarefullyanalyze