The Rise and Fall of the Ebbers Empire

John Wohlstetter
National Review Online
June 28, 2002
Print ArticleWorldCom, one-time poster-boy telecom firm for the New Economy, lies in ruins. Its 19-year saga mirrors that of the once-vibrant long-distance industry. Its imminent demise, while hastened by scandal, was inevitable.

The seedlings of WorldCom were planted on January 8, 1982 when Charles Brown, last chairman of legendary Ma Bell, capitulated to antitrust chief William Baxter. Facing imminent defeat in the government's antitrust suit, Brown elected to end his company's litigation nightmare and accept Baxter's vision of juridically separate long-distance and local markets, effective January 1, 1984.

Baxter's vision was based on, he later admitted, a "hunch": Consumer-welfare gains from scale economies generated by separating local and long distance would more than offset losses due to foregone scope economies from integration of the two. Baxter based his calculus on superior economies of terrestrial microwave transmission via radio towers spaced 30 miles apart, versus cables buried in the ground. It proved a masterpiece of bad regulatory timing: Just as Baxter achieved his goal, advances in fiber-optics began to transform the economies of long distance, and in time vertical reintegration of local and long distance would become the only sensible strategy.

Bernie Ebbers co-founded Long Distance Discount Services in 1983. He would take advantage of regulatory rules established by the Federal Communications Commission that subsidized AT&T's competitors into the early 1990s. Until then his firm flew below the radar screen. When Ebbers acquired UUNet, a company providing data services over the burgeoning Internet backbone, the re-christened WorldCom targeted the high-growth business-data market. Wall Street took notice, and Ebbers became the new star in the telecom firmament.

Aiding WorldCom's rise was that between 1990 and 1996 AT&T, MCI and Sprint, the long-distance Big Three with some ninety percent of the market, operated a cozy triopoly, passing six price increases on to customers. But the advent of the mass-market Internet in 1995 (when "Wintel" PC married Netscape's Navigator browser) signaled that the cartel's days were numbered.

The 1996 Telecom Act not only failed to introduce more competition into long distance; by erecting stiff barriers to Bell entry into long distance the law actually prolonged the cartel's life. But further advances in fiber-optic technology soon made the cost of a call across the country almost exactly the same as that of a call across the street.

The vast scale economies of fiber-galvanized entry into long distance by new fiber carriers, unencumbered by legacy networks built with older generations of fiber. Qwest, Williams Telecommunications, Level-3, and Global Crossing laid thousands of miles of fiber connecting hundreds of cities. By 1997 the core voice revenues of established carriers began to deteriorate, a process continuing today at an accelerated pace as Internet fax and e-mail displace no-rush voice calls.

Ebbers did not fully grasp this. Which explains why in 1997 he outbid British Telecom and GTE for Old Economy icon MCI, a firm distinguished not by its technology but its inspired marketing. When John Sidgmore, WorldCom's current CEO and back then its president, told Wall Street that high-flyer WorldCom planned to jettison MCI's 20 million LOLITAs (telecom-speak for Little Old Ladies In Tennis Apparel) a firestorm erupted in Washington. Within 24 hours Ebbers pledged to keep Grandma. He thus sealed WorldCom's fate: His New Economy business was now fatally entwined with Old Economy voice.

Three years later Ebbers realized this and spun off MCI's consumer business as a separate company, but it was too late. The long-distance price collapse deprived all firms of pricing power, a signal to investors that the glory years were over. Long distance is no longer a stand-alone business, a realization dawning slowly, but surely, upon the FCC, which in 1997 blocked AT&T's purchase of a Bell firm, SBC. As recently as 2000 regulators on both sides of the Atlantic so feared WorldCom that they blocked its merger with Sprint, fearing impending dominance of the Internet. They (and the local phone companies that opposed the deal) needn't have worried.

Vertical reintegration of the local and long-distance markets, separated by government fiat 20 years ago, finally beckons. Presaging ultimate vertical reintegration, Qwest in 2000 morphed into a local phone company by acquiring a Bell, USWest, with integration of local and long distance segments still awaiting slow-motion regulatory approval of USWest's entry into long distance within its 14-state territory.

The criminal fraud investigation that forced suspension of trading in WorldCom's stock had nothing to do with all this, but profoundly alters the emerging structure of the telecom industry. Courtesy of Enron and the parade of scandal that daily graces the morning headlines, telecom balance sheets are radically revalued. Stodgy Bell assets look a lot better to skeptical investors than under-capitalized fiber carriers, some already bankrupt. Enron thus made possible the acquisition, at scrap value, of newer networks with fewer LOLITAs to subsidize. Why pay a premium for a LOLITA-laden long-distance firm like AT&T and face Justice Department scrutiny, when scads of long distance fiber can be acquired without regulatory headache?

For WorldCom — and, soon, AT&T — now negotiating with lenders to spin off its cable properties without violating loan covenants limiting its balance-sheet debt — the end of the line is nigh. Within three years there will be three or four end-to-end carriers offering local plus long distance. The final number awaits whether USWest survives intact or is sundered and parceled out among the remaining Bell firms.

Regulators could still scramble the picture by trying to get the Bells to rescue WorldCom, setting a precedent for an AT&T bailout. Such "lemon socialism" could preclude consumers from realizing the full benefit of falling long-distance prices. However, the edifice elaborately constructed 20 years ago by William Baxter on a hunch, has crumbled. No other country followed Baxter's lead, and no other country has such a mess in its long-distance market.

— John C. Wohlstetter is a senior fellow at the Seattle-based Discovery Institute.