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Mci Communications Essay

1604 words - 7 pages

MCI COMMUNICATIONS CORPORATION
Introduction
In 1982, the Justice department ordered the separation of ATT into local subsidiaries. MCI was one of the main competitors of AT&T and the impact of this new competition on MCI was uncertain. In this case the financial impact of this increased competition will be analyzed.

Analysis of External Financing Needs for MCI from 1983 to 1989
Please see Exhibit 1 and Exhibit 2 MCI’s external needs will keep increasing over the next few years as the operating margins would shrink because of higher competition & higher access charges. In order to increase its market share, MCI would need to continue investing huge capitals in its network. As per ...view middle of the document...

The convertible bonds provided a cost effective way for MCI to finance a sequence of major capital investments. It allowed MCI to match capital inflows with expected investment outlays. Once the stock price rose MCI forced the conversion and 1/4

eliminated the cash flow drain from servicing the debt. The new infusion of equity can in turn be used to support additional debt or convertible financing. For exampleo MCI issued 100 million convertible offering in 1981 with a conversion price of 12.825 while the current price at that time was 10.875. o By Feb’1983, the stock price had gone above 12.825 and MCI called for conversion. It reduced its leverage. o It used this new infusion of equity to raise $400 million in the new convertible offering at conversion price of $52. This strategy worked for MCI because it was unable to satisfy its demand for huge capital from the investment grade bond markets (it had no previous track record) or from regular banks. Raising more equity would have diluted the value for existing share holders and the cost of equity would have been very high. The convertible offerings were accepted by investors at a lower coupon than straight bonds because they could get capital appreciation if the MCI stock price goes up.

Analysis of Historical and Proposed Capital Structure
In April 1983, the telecom industry was going through major regulatory changes. AT&T was being divided into smaller companies and equal network access costs were being established. MCI had a good opportunity to increase its market share. Please see Exhibit 3 for detailed analysis of Historical and Proposed Capital Structure . It also faced severe financing challenges. o Raising more equity would have diluted the value for existing share holders and the cost of equity would have been very high. o Raising debt from the investment grade bond markets was not feasible as it had a high leverage of 55-60% and it also did not have a previous track record in the bond market. o It had already exhausted most of the lines of credit with commercial banks. o It was using convertible debenture offerings sequentially, to raise capital and infuse equity at a point in future by forcing conversion. Based on the above points, I recommend that MCI should continue to maintain its historical capital structure of 55 – 60% debt.

Risk with MCI’s Capital Structure
The risk with this structure is that in face of increasing competition, its high leverage will limit its staying power. Increasing competition may lead to excess capacity and thereby decreasing the profit potential. In such a scenario the value of bonds will drop sharply and cost of borrowing will go up significantly, making it very difficult to raise new capital. So even if MCI has a very solid strategy for competing against AT&T, its growth may be severely restricted due to capital constraints.

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MCI still had to maintain its current capital structure, in 1983, because the bond markets were not...

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