MCI Communications Corporation, 1983

Harvard Business School

Case Software 2-292-737
Copyright (c) 1989 by the President and Fellows of Harvard College.
Developed in conjunction with MicroMentor, Inc., Cambridge, MA.
FY 1974 FY 1975 FY 1976 FY 1977 FY 1978 FY 1979 FY 1980 FY 1981 FY 1982 FY 1983
Revenue $0.7 $6.8 $28.4 $62.8 $74.0 $95.2 $144.3 $234.2 $506.4 $1,073.2
Operating income (15.0) (17.3) (10.6) 17.7 25.0 30.6 37.2 51.3 167.0 295.1
Net interest 3.8 11.6 15.5 18.4 20.5 23.1 24.1 27.4 35.1 54.1
Net after-tax earnings (20.1) (38.7) (27.2) (1.7) 5.2 7.1 13.3 21.1 86.5 170.8
Cash, cash equivalents $1.2 $1.4 $3.7 $2.8 $4.3 $10.3 $7.9 $12.7 $144.8 $542.0
Working capital
a
0.3 (7.4) (12.7) (18.3) (21.7) (26.9) (34.1) (24.8) 42.5 391.8
Plant, equipment 60.0 81.0 120.8 126.6 148.9 188.9 282.0 410.0 619.5 1,324.2
Total Assets 71.8 90.1 131.2 147.7 161.2 209.5 309.8 466.9 860.4 2,070.5
Short-term debt
b
1.2 4.0 9.8 17.0 20.2 25.8 31.6 39.9 40.3 48.0
Long-term debt 48.4 95.2 144.3 149.7 152.8 153.3 172.9 242.7 400.0 895.9
Stockholders' equity 19.1 (14.4) (29.1) (32.2) (22.7) 11.5 78.8 148.0 240.8 765.6
Shares outstanding
c
27.0 30.6 41.0 40.2 40.6 43.4 65.8 75.6 97.4 117.2
Earnings per share
d
($0.7) ($1.4) ($0.8) ($0.1) $0.1 $0.0 ($0.0) $0.1 $0.9 $1.7
Common stock price--low $1.5 $0.5 $0.5 $1.0 $1.0 $1.5 $2.0 $2.5 $7.0 $16.0
Common stock price--high $4.5 $2.5 $2.5 $2.0 $2.5 $3.5 $4.5 $7.0 $18.0 $47.0
d
Earnings per common share after preferred dividends, before extraordinary items.
Exhibit 2 MCI Operating History, for Fiscal Years 1974-1983 ($ millions, except per-share data)
a
Current assets less current liabilities (current assets include cash, cash equivalents)
b
Include long-term payable within one year.
c
At year-end, MCI has never paid any dividend on its common stock.
FY 1978 FY 1979 FY 1980
FUNDS FROM OPERATIONS
Retained earnings
a
$2.5 $1.6 ($1.1)
Depreciation 11.2 13.6 18.3
Other
b
2.7 3.5 7.0
TOTAL $16.4 $18.7 $24.2
EXTERNAL FINANCING
Net increase in lease obligations $10.2 $35.0 $65.4
Other net borrowing, sales of securities (4.6) (0.8) 19.3
TOTAL $5.6 $34.2 $84.7
TOTAL SOURCES $22.0 $52.9 $108.9
USES OF FUNDS
Investment in plant, equipment $22.2 $52.5 $110.3
Acquisitions 0.0 0.0 0.0
Increase in Adjusted Working Capital
c,d
(1.7) (5.6) 1.0
Change in Cash Holdings 1.5 6.0 (2.4)
TOTAL USES $22.0 $52.9 $108.9
Exhibit 3 Sources and Uses of Funds, for Fiscal Years ($ millions)
d
FY 1983 figure does not include working capital of WUI.
a
Net income less preferred dividends.
b
Deferred taxes, employee stock purchase plan.
c
Working capital excluding cash and short-term debt.
FY 1981 FY 1982 FY 1983
$7.2 $83.1 $170.8
27.2 60.8 108.6
6.1 35.2 57.1
$40.5 $179.1 $336.5
$47.7 ($32.2) ($18.3)
85.1 193.3 842.2
$132.8 $160.1 $823.9
$173.3 $339.2 $1,160.4
$155.7 $271.5 $623.0
0.0 0.0 195.1
12.8 (64.1) (55.2)
4.8 131.8 397.5
$173.3 $339.2 $1,160.4
Exhibit 3 Sources and Uses of Funds, for Fiscal Years ($ millions)
d
FY 1983 figure does not include working capital of WUI.
a
Net income less preferred dividends.
b
Deferred taxes, employee stock purchase plan.
c
Working capital excluding cash and short-term debt.
1981 1982 1983
Revenue $234 $506 $1,073
Operating expense (excl. depr.) 157 283 674
Depreciation 26 56 104
OPERATING INCOME $51 $167 $295
Interest expense 28 54 75
Interest Income less other expense 1 16 21
PROFIT BEFORE TAX $24 $129 $241
Provision for income taxes 5 43 70
NET INCOME $19 $86 $171
Extraordinary item 2 0 0
ADJUSTED NET INCOME $21 $86 $171
Preferred Dividends 11 3 0
INCOME AVAILABLE FOR COMMON STOCK $10 $83 $171
Exhibit 4 Income Statements (dollar figures in millions)
Exhibit 5 Balance Sheets ($ millions)
1981 1982 1983
Cash, cash equivalents $13 $144 $542
Accounts receivable 32 79 162
Other 4 5 9
CURRENT ASSETS $49 $228 $713
Plant, equipment (net) $410 $619 $1,324
Other 8 13 33
TOTAL ASSETS $467 $860 $2,070
Accounts payable, accrued liabilities $34 $137 $251
Accrued taxes 0 8 22
Debt due within one year 40 40 48
CURRENT LIABILITIES $74 $185 $321
Long-term debt $243 $400 $896
Deferred income taxes 2 34 88
TOTAL LIABILITIES $319 $619 $1,305
Preferred stock (Par Value) $1 $0 $0
Common Stock (Par Value) 4 5 12
Surplus capital paid-in 220 230 576
Retained earnings (deficit) (77) 6 177
TOTAL LIABILITIES, NET WORTH $467 $860 $2,070
|---------- Industrials ----------| |------- Utilities -------| |-------- MCI (c) ---------|
Preferred Convertible
Issue Date |-- Bonds (a) --| Pref'd Stock(b) Bonds (a) Stock (b) |-- Bonds (a) --| Preferred
Month Year A BBB Medium Speculat. A BBB Medium D CD Stock
December 1978 9.17% 9.76% 9.45% 10.34% 9.50% 9.78% 10.48% 10.56%
September 1979 9.74% 10.41% 9.76% 11.53% 10.05% 10.51% 10.97% 12.00%
July 1980 11.35% 11.74% 10.56% 10.91% 11.54% 12.60% 12.32% 15.00%
October 1980 12.92% 13.03% 11.43% 11.98% 12.79% 14.14% 14.32% 12.27%
April 1981 13.29% 14.18% 13.19% 13.65% 14.01% 15.17% 15.12% 16.80%
August 1981 16.25% 17.25% 13.46% 14.99% 17.50% 18.00% 15.85% 10.25%
May 1982 15.50% 16.50% 13.16% 14.62% 16.25% 17.00% 14.93% 10.00%
September 1982 13.75% 14.63% 13.21% 14.49% 14.00% 15.13% 14.11% 15.17%
March 1983 12.50% 13.00% 11.36% 12.67% 12.75% 13.25% 12.51% 7.75%
(a) S&P rating. D = Straight Debenture
(b) Rates are for non-convertible preferred stock. CD = Convertible Debenture
Exhibit 7 Comparative Interest Rates
MCI ATT GTE IBM ITT
Revenues $1.1 $65.1 $12.1 $34.4 $16.0
Net income $0.17 $6.99 $0.90 $4.41 $0.70
Assets $2.1 $148.2 $21.9 $32.5 $14.1
Returns on:
Sales 15.9% 10.7% 7.4% 12.8% 4.4%
Assets 11.0% 8.6% 4.1% 14.1% 4.8%
Equity 32.4% 12.2% 15.6% 22.9% 12.7%
Pay-out ratio 0% 67% 61% 47% 54%
Debt ratio
a
55% 43% 57% 14% 38%
Current ratio 2.2 0.9 1.0 1.6 1.3
Interest coverage(times) 4.2X 3.6X 2.4X 18.0X 2.5X
Bond rating NR AAA BAA AAA A
Price earnings ratio:
Low 8 6 6 8 5
High 27 8 10 13 7
Exhibit 8 Comparison Companies (dollar figures in billions)
a
Total Debt to Capital

NR = not rated
FY 1983 FY 1984 FY 1985 FY 1986 FY 1987 FY 1988 FY 1989 FY 1990
1. Interstate long-distance market $27,000 $29,800 $32,800 $36,000 $39,700 $43,600 $48,000 $52,800
2. MCI market share
a
4.0% 6.2% 9.6% 13.5% 18.6% 19.8% 20.0% 20.0%
3. MCI REVENUE [(1)x(2)] $1,073 $1,850 $3,160 $4,870 $7,380 $8,660 $9,600 $10,560
4. Access charges (% of sales) 16.0% 23.0% 29.5% 29.5% 29.5% 28.5% 27.5% 26.5%
5. Operating margin
b
27.5% 20.5% 12.0% 12.0% 12.0% 13.0% 14.0% 15.0%
6. OPERATING EARNINGS (EBIT) [(3)x(5)] $295 $380 $390 $590 $890 $1,125 $1,345 $1,580
7. Interest paid 75 100 100 100 100 100 100 100
8. Otherincome 21 13 3 4 4 5 5 5
9. Provision for taxes 70 83 58 123 206 299 400 475
10. AFTER-TAX NET INCOME
[(6)-(7) + (8)-(9)] $171 $210 $235 $371 $588 $731 $850 $1,010
11. Increase in deferred taxes $53 $65 $88 $106 $120 $140 $146 $140
12. Incremental investment factor 1.15 1.15 1.12 1.10 1.08 1.06 1.04 1.00
13. Capital expenditures for new capacity
[Change in (3)x(12)] $623 $890 $1,467 $1,881 $2,710 $1,357 $980 $960
14. Capital expenditures for replacement -- -- -- 50 50 100 100 100
15. TOTAL CAPITAL EXPENDITURES
[(13)+(14)] $623 $890 $1,467 $1,931 $2,760 $1,457 $1,080 $1,060
16. Depreciation $104 $173 $272 $412 $601 $749 $800 $826
17. Net plant, equipment (end of year) 1,324 2,041 3,236 4,755 6,914 7,622 7,902 8,136
18. Additional working capital required 0 0 0 0 0 0 0 0
b
Includes depreciation as a cost.
Exhibit 9A Baseline Forecast of Anticipated MCI Operating Characteristics For Fiscal Years 1983-1990 ($ millions)
a
This is total MCI revenue as a fraction of long-distance revenue and includes non-long-distance revenues (e.g., from WUI). MCI actual
share of the interstate long-distance market would be slightly lower.
(f) Other Income represents interest on holdings of cash equivalents. As "excess" cash is used up
this figure is expected to decline to $3 million and then grow roughly with sales. This projection
does not include interest on the proceeds of any future security offerings that are added
temporarily to cash.
(g) Provisions for taxes (line 9) amounts in 1984 to 25% of net income which is below the 46%
base rate because of investment tax credits and other special credits. As growth and investment
slow in later years, reducing the available credits, taxes as a percentage of net income should
increase.
Exhibit 9B Assumptions Underlying the Forecasts of Exhibit 9A
(a) The interstate long-distance market, which amounted to about $27 billion in FY 1983, would
grow at 10%/year through FY 1990.
(b) MCI's revenue would increase from 4% of total long-distance revenue in FY 1983 to 20% in FY
1990. The increase would be rapid in the years immediately following the advent of "equal
access," but would subsequently slow down as AT&T began to defend its reduced share of the
market, other competitors developed their networks, and the market itself adapted to the shock of
competition. This pattern is shown on line (2) of Exhibit 9. In each year, 10% of MCI revenues
would come from other than long-distance growth. Thus, in FY 1990 MCI was projected to hold
18% of the long-distance market. MCI's management was believed to be committed to a growth
program of the dimensions shown on line (3) and would, if necessary, sacrifice profit margins to
achieve it.
(c) Access charges paid by MCI would slightly more than double between FY1983 and FY1985.
They would then taper off to about 26.5% of total revenue in FY1990. This was consistent with
announced FCC intentions at the end of March 1983. However, there was a great deal of
uncertainty in this area. AT&T currently paid access charges amounting to more than 50% of
revenue, and reductions to the levels on line (4) would depend on the imposition of "direct access"
charges on households and businesses. Legislation in Congress with a reasonable chance of
passage forbade the imposition of such "direct access" charges.
(d) MCI's operating margin (operating earnings as a fraction of revenue) would shrink under the
dual pressure of higher access charges and increased competition from both AT&T and other long-
distance suppliers. Ultimately, however, as access charges fell and the market stabilized, margins
were expected to recover to a levelof about 15%. Anticipated yearly margins are shown on line (5).
However, as noted above, these were subjected to substantial uncertainty. In the best case,
favorable regulatory and legislative action, coupled with restrained competitor behavior, might
increase margins by as much as 7% (up to 22% of sales) from these levels. In an unfavorable
situation, severe competition and high access charges could reduce margins by an equal amount.
(e) Interest payments of MCI's outstanding debt were running at an annual rate of about $100
million at the end of FY1983 (for the year as a whole interest payments were only $75 million
because the debt level increased during the year) and, with no net change in indebtedness, would
remain stable at this level through FY1990.
(k) Depreciation would be charged at an annual rate equal to 9.8% of the value of plant and
equipment in place at the beginning of each year plus 4.9% of the value of total new investment.
(l) No additions to working capital would be required throughout the period and any cash on hadn
at the end of FY1983 could be devoted to investment programs.
(m) MCI would not penetrate intrastate toll market.
(h) Increases in deferred taxes (line 11) accumulate at a rate related to present and past capital
expenditures. As growth slows, so does the rate of accumulation of deferred tax credits.
(i) In March 1983, each extra dollar of revenue required about $1.15 worth of investment in fixed
plant and equipment. This factor was expected to fall to about $1.00 by FY1990 as improved
electronic technology reduced equipment costs. The expected yearly pattern is shown on line (12).
It was possible, however, that in the latter part of the period (post-FY1987), this factor would fall
substantially below $1.00.
(j) Replacement of older equipment would require the investments described on line (13).