MCI

MCI Communications Corp., 1983

MGT 231 Corporate Finance

MCI

The Team’s Role:

Answer Question: What should MCI do now?
• Executive Summary
• Recommendation
• Past Financing Strategies and
Financial Condition
• Competitive Analysis
• Financial Projection
• Target Capital Structure
MCI

Executive Summary:
• MCI CFO has decision to make
• Set financial policy
- uncertainty regarding MCI’s future
- large demand for external financing
• Dept of Justice, Ma Bell
• MCI and AT&T compete on equal basis
-on one hand = good growth potential
-on the other = loss of cost advantage
• MCI committed to expansion and growth

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MCI

Recommendation
“Capitalize on the opportunity for
(a) equal access
(b) network expansion (own facilities for
basic call services, which can be
leveraged off to provide profitable value-
added services)”
“Review financial policy; augment $550
million cash on hand with external
financing, i.e., equity”

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MCI

Background (1 of 3)
• 63: Microwave Communications Inc. is founded
• 71: FCC allows specialized services
• 72: MCI goes public: IPO
• 73: MCI suspends construction activity
• 74: MCI files antitrust suit against AT&T
FCC orders AT&T to supply interconnection
Resumes construction of network
Introduces “Execunet” service
• 75: MCI issues second equity

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MCI

Background (2 of 3)
• 76: MCI first profit
Execunet restricted by Court
• 77: Court rules MCI may offer Execunet
• 78: Execunet restrictions lifted
Issue first convertible preferred
• 79: Issue second convertible preferred
• 80: Denver residential trial
Issue first debenture
Issue third convertible preferred

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MCI

Background (3 of 3)
• 81: Issue second debenture
Issue first convertible debenture
• 82: Antitrust settlement with AT&T
Issue second convertible debenture
WUI acquired
Issue third debenture
Revenues doubled to $506M
• 83: Revenues doubled again to $1.1B
Issue third convertible debenture
Case situation
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MCI

Past Financing Strategies

MCI

Past Financing Strategies, Exhibit 6 (cont.)

Team Front Row
MCI

Convertible debt:
MCI, 1983 (in millions)      
Why? Liabilities $ 1,305
Stockholder's Equity 765
Total Assets $ 2,070 Total Liabilities & Stockholder's Equity $ 2,070
• MCI raised capital without giving up too much control of
ownership
• MCI found the middle ground between debt and equity,
and balanced interest tax shields against costs of financial
distress
• MCI aligned interests of bondholders & shareholders
• MCI circumvented signaling problem

What kind of companies issue convertible debt?

– rapidly growing firms facing heavy capital
expenditures including General Mills, Ford, etc.
(low coupon rate, conversion option sweetens deal for investors, see Exhibit 7)
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Team Front Row
MCI

Current Financial Condition

 MCI

Two useful Ratios:

1. Debt-to-Total Assets
measure of risk of default
Total Debt (Exh.5, in millions) $1,305
0.63 or 63%
Total Assets $2,070
Indicates MCI is a highly leveraged firm. The higher the percentage,
the greater the risk that MCI will not meet its debt obligations.
2. Times Interest Earned
measure of ability to meet interest payments
EBIT (Exh.4, in millions) $316
4.21 times
Interest Expense $ 75
Indicates MCI’s ability to meet interest payments when they become
due. The higher the number , the better.
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MCI

Competitive Analysis
• A glance at AT&T
AT&T has “superior access” lines for long
distance customers
MCI pays AT&T
 for connecting its subscribers through local
telephone networks
o enabling its customers to reach areas not served
by the MCI network
AT&T controls 95% of the market

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MCI

Competitive Analysis
MCI launched Execunet service (huge success)
and MCI Mail
1983 Antitrust Case
– MCI and ATT compete “equally” for long distance
customers
MCI’s access charges increases by 80%, but it
loses cost advantages while AT&T loses “superior
access”
Uncertainty in regulatory world, breakup of AT&T
MCI commits to expansion
– 4% to 20% of market by 1990
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MCI

Future Financing Needs, 1984 – 1990

MCI Sources of Funds ($ millions), Exhibit 9A FY1984 - FY1990
A Funds from Operations
Retained Earnings 3,995
Depreciation 3,833
Total 7,828

B External Financing
Other net borrowing, sale of securities
Total 2,817 ← plug

C Uses of Funds
Investment in plant, equipment  
Total 10,645

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 MCI

Target Capital Structure

• Finance dramatic opportunities for growth by issuing equity

MCI (in millions) 1983 1990     1983 1990

Liabilities 1,305 1,305
Stockholder's Equity [765 + 2,817] 765 3,582
Total Assets $ 2,070 $ 4,887 Total Liabilities & Stockholder's Equity $ 2,070 $ 4,887

Debt-to-Total Assets Ratio 63% 27%

Times Interest Earned Ratio 4.21 15.85

• Pecking Order Theory:

Dividends are sticky, internal financing first, debt financing next, equity financing last
• Why equity?
– Competition: severe competition and high operating costs could reduce
operating margin. Less margin = less money to cover interest payments =
default = bankruptcy
– Restrictive debt covenants: might restrict capital expenditures
– Taxes: reduced tax benefits as investment and special tax credits phase out
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