net.wars: Get big fast, get small faster
by Wendy M Grossman | posted on 28 June 2002
It's another one of those irregular verbs, as made famous by Anthony Jay and Jonathan Lynn in "Yes, Minister." I make an accounting error. You engage in creative accounting. They are WorldCom.
Worldcom miscategorizes $3.8 billion in ordinary running costs as capital expenditure and may have to file for Chapter 11 bankruptcy protection; it does seem beyond simple creative accounting. Though there is one gambit they could try first: asking for a tax refund, since if they paid corporate tax on a bunch of profits that were in fact losses, they shouldn't have owed that tax in the first place.
Until a few days ago, most people pinned the beginning of the dot-com boom to Netscape's successful IPO. To me, Worldcom was the prototypical dot-com company, though I didn't have that phrase available when I wrote about it for the Telegraph in 1997 . Born in 1983 in the wake of the AT&T breakup as a scrawled idea on a napkin in a Mississippi diner, by 1997 Worldcom had become the world's fourth largest telecommunications company. You don't achieve that organically, and Worldcom didn't: it marched to largeness and prominence through a series of some 60 acquisitions, all but one through stock swaps.* It dropped its original name, Long Distance Discount Service, and took Worldcom from a business it acquired in 1995. It owns a huge amount of the world's Internet backbone, for those prone to worrying about the Internet's future.
The amazing thing is not that a disaster of these proportions has happened to such a large - but young - company. The slightly amazing thing is that it wasn't AOL. Not that there's anything wrong with AOL that removing all its graphics and some of its users wouldn't cure, but it's had accounting snafus of its own. But in April, AOL Time Warner declared a $54.24 billion quarterly loss, due to changes in accounting rules requiring it to write down good will that previously could have been amortized over a longer period.
A few years back, The New Yorker ran an amusing little graphic comparing the boom-and-bust stock price of the gambling instrument of 1925 to 1929, Radio Corporation of America, and that of AOL. The graphs, up to their peak, matched almost exactly. In five years, RCA's stock went from about $11 to a high of $573 1/4 in September 1929 (ignoring the five to one split that February). Most of that rise started in 1928. At its peak, its price/earnings ratio was 72:1, unheard of in those days (though of course, now we've lived through P/E ratios in the thousands, and high prices with no earnings at all). Overall, RCA stock went up 10,000 percent in those five years. You can't pay too much for radio! Then from 1929 to 1932 RCA fell 98 percent.
RCA is a favorite cautionary tale. Here it's being compared to Microsoft, 1993 to 1997. But past performance is no guarantee of future results, and so we have people who are probably not unhappy if they bought Microsoft in 1997. Not, at any rate, compared to Worldcom shareholders . If that URL goes bonkers on you, it's supposed to be a graph from BigCharts.com comparing Worldcom's and Microsoft's share prices over the last five years. Microsoft went up more, stayed there longer, and declined less, even before the doubts about Worldcom started creeping in, reflecting as much the mess that is telecoms as Worldcom's debt load and Microsoft's massive hoard of cash. If you're in a market bust, cash is king.
But timing is everything. Worldcom might have survived its announcement if it had been made in 1999, or even late 1996, when AOL was required to change the way it had been amortizing new users and declared a loss bigger than all the profits it had ever declared put together. In the giddy heights of 1999, a mere $3.8 billion might have been unnoticeable. In fact, if Worldcom could have called it investment in "getting big fast" , announcing such a loss might have spurred the stock to new heights. But the after-shocks of the Enron debacle are far more profound than those of September 11, and in this market if General Electric announced it had lied about spending $25 on Luak coffee there would be an outcry and calls for investigation.
OK. So where does that leave the average investor? We can't trust earnings, we can't trust accountants (I bet everyone at KPMG, PWC - oh, I do beg its pardon Monday , and is that a death wish name, or what? -- and Deloittes is breathing huge sighs of relief that Andersen was the accountant at the wheel at Worldcom) and we can't trust analysts. Interest rates are so low that bonds and savings accounts don't look so good to people who are trying to build their retirement funds back up. Best guess: look for dividends. Those you can bite yourself to see if they're real.
*Incredibly enough, the exception was Worldcom's purchase of BT's share of MCI. BT insisted on cash. Worldcom called them fools and warned they'd face shareholder lawsuits. BT demanded cash anyway.
Wendy M. Grossman’s Web site has an extensive archive of her books, articles, and music, and an archive of all the earlier columns in this series. Readers are welcome to post here, at net.wars home, follow on Twitter or send email to netwars(at) skeptic.demon.co.uk (but please turn off HTML).
net.wars: Get big fast, get small faster