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Caught In The Middle

In the wake of WorldCom's troubles, customers weigh options

Financial scandal struck a nerve last week, as thousands of business-technology managers were forced to confront the troubling prospect that WorldCom's financial problems jeopardize their voice and data networks.

Swift assessment and action are crucial in the coming days, as managers review their contracts with the $21 billion telecommunications company and determine whether to switch to another provider. Assuming the company remains viable, customers have several concerns. With a smaller staff and reduced capital budget, WorldCom's quality of service may deteriorate and repairs may not happen in a timely fashion. The one-stop shopping for voice, data, Internet, hosting, and other services that lured customers to WorldCom in the first place may cease, resulting in customers having to deal with multiple providers.

The decision will become more complicated if WorldCom, whose stock sank below $1 last week, files for Chapter 11 bankruptcy, which is likely. Nearly a third of 254 WorldCom customers polled by InformationWeek last week plan to switch network carriers, and 28% will consider switching to another carrier, resulting in major logistical and financial challenges.

The Securities and Exchange Commission last week launched an investigation into WorldCom's accounting, and President Bush said the Justice Department would begin a criminal investigation. Following an internal audit, the carrier disclosed that it had improperly reported $3.8 billion in expenses, resulting in inflated earnings statements. In response, WorldCom fired its CFO, Scott Sullivan and accepted the resignation of VP and controller David Myers. WorldCom also started laying off 17,000 people in a cost-cutting measure expected to save $900 million annually.

WorldCom

WorldCom has admitted to improperly transferring line-cost expenses worth $3.8 billion to its capital accounts, resulting in inflated earnings statements.
This isn't just another telecom company weighing a bankruptcy filing. The fallout could be far-reaching: 70% of E-mail in the United States and more than half of worldwide E-mail travels over WorldCom's Internet backbone, the largest in the world. If WorldCom were to shut its doors-an unlikely event-the Internet could crash. What's more, the company's 93,000 miles of fiber circuits provide voice, data, and video service in more than 100 countries, connecting many big businesses, including British Petroleum, FNB, and Toyota, to their global offices and suppliers.

"It's definitely time to evaluate your contractual situation and to make sure that you have alternate arrangements," says Jim Blaszak, a partner in Washington law firm Levine, Blaszak, Block & Boothby LLP, which helps large companies negotiate telecom contracts. But there's a limit to what customers can do. Most contracts impose significant financial penalties for early termination.

Terminating a deal for convenience, which would apply if a customer tried to exit a contract because of uncertainty about a vendor's financial condition, usually carries the most significant penalty-around 50% of the remaining contract value.

Other escape clauses sometimes provide that either party can cancel a contract if one declares bankruptcy. But it's unclear whether bankruptcy laws actually let the parties do that. "The odds aren't good that a customer would be able to walk away from a contract simply because the carrier files for bankruptcy," Blaszak says. "People shouldn't do anything rash right now. They need to take a deep breath, look at their contracts carefully, continue to monitor WorldCom's performance, and consider their options."

That's what Market News International Inc., a New York financial news and information provider, is doing. "My concern, which existed previously, has gone way up," CFO John Campanella says.

Market News uses WorldCom for private-line, frame-relay, remote-access, and long-distance voice services. For now, Market News won't switch providers, because it doesn't believe WorldCom's network infrastructure is at risk. But if something does happen "for us the timing is pretty good, because our contract is up for renewal," Campanella says. As Market News grows and add circuits, Campanella says he'll assess whether WorldCom is the right long-term partner.

Customers whose contracts aren't easily terminated should move high-priority traffic to other carriers to lessen the damage that could be caused by a sudden cessation of WorldCom service, says Don Carros, a senior research analyst at Meta Group. "It's time to identify critical business traffic and move it over to another carrier," he says.

But switching isn't easy. It can take six months to move a major data circuit and a full year to switch a nationwide network, Carros says. During that year, businesses can expect to pay 10% to 30% more for services because they'll be running dual networks in each phase of the switch.

Those and other considerations have convinced Ryder System Inc. in Miami to stick with WorldCom for its voice and data services, at least for now. To negotiate a new contract, the logistics and transportation company would have to to compile data to get a sense of its telecom volume and then determine which carriers offer service in all its 600-plus locations. "They're going through a tough situation, but things will work out," says Eduardo Vital, CIO and executive VP. "We'll stay with them." Vital says he spoke with a WorldCom executive last week who assured him that Ryder's service wouldn't be disrupted or degraded.

Meanwhile, WorldCom's competitors are gearing up for an onslaught of new customers. One Sprint executive says inquiries were up as much as four times their normal level last week, as companies whose WorldCom contracts have expired or are about to expire-and those looking for backup services-investigate their options. AT&T claims it has excess capacity on its network and the administrative resources to process, and provision new orders within a few weeks. Local access lines may be another story; they often take 30 to 90 days to install.

Andrews & Kurth LLP, a law firm in Houston, added a termination clause in a recent contract it signed with WorldCom for 155-Mbps metropolitan-area Ethernet service, because it eventually wants to build and manage its own Ethernet links, CIO Lynn McGuire says. "We'll stick with WorldCom, but we'll have contingencies in place," he says. "I'm not worried at this point that WorldCom will shut down all the services." However, he's nervous about whether WorldCom and its contractors will be able to respond to service outages.

What WorldCom will be able to do remains unknown. CEO John Sidgmore tried to set a calming tone. "I want to assure our customers and employees that the company remains viable and committed to a long-term future," Sidgmore said in a statement last week. Lawmakers subpoenaed Sidgmore, former CEO Bernard Ebbers, and Sullivan to testify at a July 8 hearing of the House financial-services panel.

Analysts aren't so optimistic. "WorldCom's definitely going to go into bankruptcy," Meta Group's Carros says. As part of a recovery plan, WorldCom may try to keep its data and Internet businesses by selling off its global and voice long-distance assets to raise cash. Or, under a bankruptcy proceeding, WorldCom's creditors could force a sale of the company in an effort to maximize creditor payments. BellSouth, EDS, IBM, SBC Communications, and Verizon Communications are the most likely buyers, Carros says.

But if WorldCom fails to find a buyer and runs out of the cash it needs to run its network, the result could be a sudden and catastrophic shutdown of services-the least likely but most damaging outcome of all. "As a corporation, you don't even want to think about that happening," Carros says.

At a minimum, it's something WorldCom's customers may want to ponder.

-with Diane Rezendes Khirallah

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