NEW YORK (CNN/Money) -
News of fraudulent accounting at WorldCom sparked a major sell-off in the telecom sector -- no surprise there.
Competitor AT&T and major telecom suppliers, including the already reeling Lucent, Nortel and Juniper Networks, got crushed.
But the WorldCom fallout didn't end there: Financials got hit and -- perhaps most surprisingly -- the biggest drubbing was saved for cable and media stocks.
Who's exposed?
Financials were hammered due to fears that banks with outstanding loans to WorldCom will be left holding the bag if the company files for bankruptcy, a scenario that has become increasingly plausible.
WorldCom (WCOM: Research, Estimates) had $2.3 billion in cash on its balance sheet as of March 31, and debt of just $858 million due by March 31, 2003, a manageable level in the short term.
But Patricia Lee, an analyst with fixed-income research firm CreditSights, says the company will need to raise more funds to meet obligations that come due during the next few years. Lee says that WorldCom has total debt of $3.25 billion due next year, $2.5 billion in 2004 and $2.4 billion in 2005.
In May, WorldCom tapped a $2.65 billion credit line with banks. And the company was recently in the process of negotiating for a new $5 billion loan package.
But investors are worried about its chances, given the news of accounting fraud. "Would you want to be the bank loan officer saying that you think you should extend more credit to this company?" says Jerry Paul, managing partner of Quixote Capital Management, a Denver-based hedge fund that invests in telecom securities. Paul says he does not have a position in WorldCom stock or bonds.
If WorldCom files for Chapter 11, several banks will probably need to take charges to account for bad WorldCom loans. Citigroup, J.P Morgan Chase and Bank of America were the lead banks for the May credit facility.
Lee estimates that Citigroup and J.P. Morgan Chase each have about $150 million in exposure to WorldCom from this line of credit. In addition, Citigroup and J.P. Morgan Chase were the lead banks in a separate $1.5 billion secured loan to WorldCom in May. Citigroup did not return calls seeking comment.
A spokeswoman for J.P. Morgan Chase said that the impact from a WorldCom bankruptcy would be "very small and immaterial to earnings." And a spokeswoman for Bank of America said that published estimates about its exposure to WorldCom, which ranged from $130 million to $150 million, were "inaccurate". She would not give an exact figure, however.
Tom Finucane, manager of the John Hancock Regional Bank fund, says that Wells Fargo, FleetBoston and Bank One also have significant exposure to WorldCom -- between $65 and $70 million each -- as syndicate lenders. He also mentioned Mellon Financial as a participant in this loan package. Mellon issued a press release on Wednesday afternoon saying that it had $100 million in loans outstanding to WorldCom. Spokespeople for Bank One and Wells Fargo refused to comment. Fleet did not return calls seeking comment.
Shares of these seven bank stocks all fell Wednesday on the news. But considering that most big banks did not run into major credit problems as a result of bankruptcies by Enron, Kmart and Global Crossing, it seems unlikely that a WorldCom bankruptcy would severely hurt these banks, says Mike Stead, manager of the Wells Fargo SIFE Specialized Financial Services fund.
"Most banks have loan loss reserve positions to handle WorldCom," he says. In fact, Stead says he bought shares of Mellon on Wednesday morning because he thought the decline in that stock was particularly overdone.
How reliable is EBITDA?
The hits on cable and media were even worse, with AOL Time Warner (owner of CNN/Money) plunging 11.5 percent while Cox and radio operator Clear Channel Communications each fell about 10 percent.
Brooks Dexter, senior managing director of USBX Advisory Services, an investment bank based in Los Angeles, says concerns about the similarities between cable companies and WorldCom were one reason for the sell-off. "From a financial model these companies look a lot like a telecom," he says.
Companies in the cable sector tend to carry a lot of debt, and like WorldCom, are typically judged according to EBITDA. Unlike "net income", EBITDA does not get penalized by the depreciation and amortization of large assets (like telecom networks and cable systems).
In the past, EBITDA numbers were subject to little criticism but post-WorldCom, investors are worried. "Anybody whose main benchmark is EBITDA could come under speculation for accounting issues," Lee says. If EBITDA can be easily manipulated "then there should be concerns about other shoes to drop."
Of course, this is not to say that any company using EBITDA is a house of cards. The problem is not the method of accounting as much as it is the abuse of those methods. "Fraud is fraud," says Paul, adding that the WorldCom debacle won't change the way he analyzes telecom and other capital-intensive businesses.
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