Bernie Ebbers & WorldCom - When The Tide Goes Out…

[00:00:09] Morning folks and welcome to today's episode. It's called Bernie Ebbers and WorldCom, When The Tide Goes Out. And the whole WorldCom scandal, it never really registered with me because it happened straight after the dot-com bubble burst. So myself and my co-founders, we were just, I suppose, dusting ourselves off and realising that we weren't going to suddenly become business tycoons.

[00:00:32] And on top of that, the whole Enron scandal had exploded just a bit before. So that was really the story that consumed me back then. So when WorldCom went bust, I just didn't really give it a lot of time. But I knew that in the back of my mind that there was a great story here because you have Bernie Ebbers, this six foot four, honest to goodness, church going cowboy, who kind of came from nowhere to all of a sudden building one of the biggest telecom companies in the USA.

[00:01:00] Until suddenly it all collapsed, becoming the biggest bankruptcy in US history, like far surpassing Enron. And I'm so glad that I finally got round to digging into this story because it really is a cracking one. Enjoy. So Bernie Ebbers, born in 1941 in Edmonton, Alberta, Canada. And like, while the family did move around a bit, they moved back to Canada and Ebbers lived there up to the age of 23.

[00:01:27] And that was news to me because my image of Ebbers was always of this southern cowboy figure. But as we'll see, that comes later. Now his dad sold hardware, his mother was a housewife, money was always tight, but they had their belief. They were devout Christians and Ebbers stayed devout and active in church throughout his life. After graduating from high school, he worked as a milkman, then a bouncer.

[00:01:54] But at six foot four, he was a pretty decent basketball player. And in 1964, he got a basketball scholarship to Mississippi College. But before his senior season was over, he got a career ending knee injury. Now instead of cutting him loose, in fairness, the college gave him the job as head coach of the junior varsity team. And he graduated in May 1967 with a degree in physical education. And he taught in high school for a few years, also taught basketball, got married.

[00:02:23] He and his first wife, they had three daughters. He then got a job as a manager in a garment warehouse. But then in 1974, he started his first business. Ebers bought a run down 40 room motel in Columbia, Mississippi. And he and his family, they lived in a two bedroom trailer in the parking lot while he tries to get this place off the ground. And he does. He runs a very, very tight ship. He watches every penny. He questions every expense. And he makes it work.

[00:02:53] Like by 1982, he has 12 motels and a car dealership. Now, while Ebers is quietly building his small business, something much bigger, something much more significant is happening in the telecom sector in the US. So for some context here, AT&T up to this stage had been the big beast. It was founded by Alexander Greenbell in 1885.

[00:03:17] And over the following century, it either bought up or squeezed out most of its competitors until it controlled like virtually the entire American world. American telephone system. It was a monopoly that was accepted and regulated by the US government. Now, it did have competitors like MCI, who features in this story.

[00:03:37] And they were the ones who were bringing up these legal cases that eventually led to all these antitrust battles that led to AT&T in 1982 to agreeing to break itself up. And this opens up the long distance market to competition. So smaller companies can now get into the telecom business without having to build their own telephone network.

[00:03:57] And so in 1983, a handful of Mississippi businessmen, including Ebers, they meet up in a coffee shop in Hattiesburg and they decide to get into telecom's business with a pretty simple idea. They're going to buy long distance minutes in bulk from the likes of AT&T and then sell them at a discount to smaller businesses that the biggest telcos had kind of ignored.

[00:04:18] And according to local legend, it's the waitress in the coffee shop who suggests the very catchy name, Long Distance Discount Service or LDDS. Now, Ebers and his co-founders, they only had to put $650,000 to start the business. They got that from a local bank and they use it to buy the computers which needed to route the calls. Now, up to this point, Ebers, he was simply a passive investor.

[00:04:45] But by 1985, LDDS, it was struggling. And the other investors, they turned to Ebers and they asked him to run it. And Ebers, he runs the company in much the same way he ran his motels. So very tight operation, constantly looking for costs that can be cut. And by combining this with a focus on going after small, medium-sized businesses, he starts to turn the business around. In 1986, revenues hit $8.6 million.

[00:05:15] But you see, Ebers realises that in telecoms, like any business where scale drives down costs, the more minutes he can buy, the cheaper the wholesale rate he can negotiate. So he started buying smaller regional telephone companies. And each acquisition brings some obvious cost savings. You don't need two layers of middle management, two sets of offices. But Ebers is much better at really cutting costs than he is at actually integrating the companies he's buying.

[00:05:45] Because he becomes so focused on growth through acquisition. Behind the scenes, many of the acquired companies, they still continue using their old systems and processes. But for the moment, the huge growth, it hides all that mess. By 1988, revenues are at $95 million. A year later, in 1989, LDDS merged with a struggling publicly traded company. So a reverse takeover.

[00:06:10] And in very simple terms, this allows LDDS to become a public company without going through the traditional stock market flotation. This is important because Ebers now has publicly traded shares. So he doesn't need cash. He can use the rising share price to fund even bigger acquisitions. Revenue in 1991 reaches $263 million. Just two years later, it's $1.5 billion.

[00:06:36] And in two more years, 1995, revenues are $3.6 billion. So in just four years, Ebers has increased revenue almost 14-fold. And the growth has come from over 40 acquisitions. And it has made LDDS the fourth largest telco in the US behind AT&T, MCI and Sprint. Also, in 1995, LDDS was renamed WorldCom.

[00:07:03] And a year later, Ebers pulled off the biggest deal up to that stage buying MFS Communications in an all-chair deal worth around $14 billion. Now, the importance of this deal was the timing. Because it gave WorldCom ownership of local fibre networks in major cities. And this was when the internet boom was just about to take off.

[00:07:26] Now, tied into this, over the years, Ebers had started building a relationship with a telecom analyst called Jack Grubman. Regular listeners, you might remember Grubman. He made an appearance in the Sandy Weill episode. He was involved in a scandal where he upgraded AT&T's ratings in order to curry favour with Wheel. Anyway, that was a few years later. In 1996, Grubman was the most influential telecom analyst on Wall Street.

[00:07:54] And as I mentioned in the Uri Milner episode, during the dot-com boom, analysts were becoming celebrities within the business world. And because all of this internet traffic has to travel through the telecom networks, companies that are well positioned for the boom, like WorldCom, suddenly become part of the internet coverage. So, Ebers now has Jack Grubman, the star telecom analyst on Wall Street,

[00:08:20] constantly telling investors that WorldCom is the bee's knees. Now, look, in fairness, Grubman isn't the only one hyping the company. Most analysts and publications can see its growth. And they can see how it's so well positioned to take advantage in the huge demand that's coming from the internet. For example, in 1997, Time Magazine included Ebers among its cyber elites and told its readers that WorldCom is here to stay.

[00:08:47] And all of this praise or hype, it matters because it helps push WorldCom's share price higher. By 1997, the company's market cap was more than $30 billion, making it more valuable than MCI, the second largest telco in the US. And like MCI had revenues of $18.5 billion, WorldCom's revenues was $5.6 billion.

[00:09:12] So, MCI is bringing in more than three times as much revenue, but Wall Street believes WorldCom is worth more. And because Ebers uses WorldCom's ever-increasing share price to buy companies, this gives them enormous buying power. And he takes advantage of this in October 1997 by making an unsolicited $30 billion bid for MCI.

[00:09:35] This is huge news because at that time, it is the biggest takeover bid in American corporate history. Now, for a bit of background on MCI. The company had started life in the 1960s. It built a series of towers between Chicago and St. Louis and offered businesses a cheaper alternative to AT&T. Then in 1966, a very interesting character called Bill McGowan invests $50,000 in MCI,

[00:10:03] takes control of the company, and he is this relentless, chain-smoking workaholic. I'm definitely going to be doing an episode on him. So, it's McGowan who launches the huge antitrust case against AT&T, one of the legal battles that eventually helps bring about AT&T's breakup. And McGowan grew MCI into the second largest long-distance provider in America. MCI also helps build a government-backed network that becomes one of the foundations of the modern internet.

[00:10:32] So, by the 1990s, MCI is carrying not only telephone calls, but a huge and rapidly growing amount of internet traffic. So, my first question when I found that out is, if MCI is carrying so much internet traffic, why isn't Wall Street as excited about it as it is about WorldCom? Well, the problem is that more than 90% of MCI's revenue still comes from traditional long-distance telephone calls, and the price of those calls is falling fast.

[00:11:02] Anyway, in 1994, British Telecom, or BT, they buy a 20% stake in MCI, and two years later, they agree to buy the remaining 80% for around $22 billion. But, in July 1997, MCI revealed that its expansion into local telephone services is losing way more money than they expected, around $800 million. So, BT shareholders are furious, and the takeover offer is cut to around $19 billion.

[00:11:31] And, of course, as a result of this, MCI's board isn't happy, and this creates the opening for Ebers. And he goes in with a $30 billion all-share bid. And then, it turns into a bidding war, forcing WorldCom to increase its bid to $37 billion. By the time the deal eventually closes in September 1998, its value is closer to $40 billion, making it the biggest corporate merger ever up to this point.

[00:11:59] Now, the logic behind the deal seems pretty good. MCI brings millions of new customers, a huge long-distance business, and, combined with WorldCom, they now control more than half of all the internet traffic moving across America. So, WorldCom can now go to large companies and offer everything. Local calls, long-distance calls, international calls, and internet services, all in the one package. So, of course, Wall Street loves it.

[00:12:29] WorldCom's share price surges, and Jack Grubman tells investors, there's no telecom stock in the world that will be anywhere near the performer WorldCom will be over the next several years. Now, on a side note here, and I think you already know this, Grubman isn't an impartial analyst. Like, his investment bank is earning huge fees from WorldCom's constant deal-making. And at the same time, the bank is giving Ebbers access to shares

[00:12:57] in these red-hot internet companies before they go public. Shares that Ebbers can then sell almost immediately for huge profit. Between 1996 and 2001, these deals make Ebbers around $11 million. And not everyone thinks, you know, the MCI deal is such a great deal. As mentioned, MCI's core business is traditional phone calls, and the price of those calls is collapsing as competition increases. Analysts also point out that the network itself is getting old

[00:13:25] and will need to be upgraded or replaced at a huge cost. And there are also serious questions about whether Ebbers can run a global business with almost 80,000 employees. But neither Ebbers nor his cheerleaders on Wall Street seem particularly worried. And I think the reason is that they're all so focused on WorldCom's, you know, ever-increasing share price, and they're also distracted by the internet boom. Because with the market booming and its share price rocketing,

[00:13:55] so many people during the internet boom, and hands up, I was caught up in the frenzy myself in the belief that this was something new. This was totally different to anything before, and it wasn't a bubble. I mean, how naive we were. It was just assumed that the good times would continue, and that WorldCom's rising share price will carry them through whatever problems they might encounter. And the MCI deal, it turns Ebbers into this national celebrity.

[00:14:23] And this is when I first really became aware of him. So the financial press becomes fascinated by this former motel owner who lives on a farm, who drives a tractor and teaches Sunday school every week. And he did. That wasn't performative. Ebbers' religion and his belief is very important. He even begins every WorldCom board meetings with a prayer. And members of the Baptist church that he attended described him as being grounded, accessible,

[00:14:50] and genuinely committed to the local congregation. Like, as CEOs go, Ebbers was a very likeable character. The following is from a Newsweek profile of Ebbers, straight after the MCI deal. He doesn't fit the image of the modern mega-mogul. With his southern charm and down-home manner, not to mention his cowboy boots and leather vests, Bernie Ebbers seems more the Mississippi basketball coach he once was than a guy who we dazzled Wall Street

[00:15:18] with the biggest takeover bid this country has ever seen. And of course, all of this attention also gives us a much clearer insight into how Ebbers actually operated. Because in the interviews and profiles published after the MCI deal, he makes it pretty clear that he doesn't get involved in the nitty-gritty of the business. Here's a quote from him. I'm not an engineer by training. I'm not an accountant by training. My job is to bring people in who do have those specific skills

[00:15:48] and then rely on them. I'm the coach. I'm not the point guard who shoots the ball. And in an interview with Time magazine, he goes even further. The thing that has helped me personally is that I don't understand a lot of what goes on in this industry. So the person Ebbers does rely on more than anyone else is his CFO, Scott Sullivan. And in one of the interviews that I read with Ebbers shortly after the MCI deal, whenever the reporter asked Ebbers for any detailed financial information,

[00:16:17] he simply turned around to Sullivan for the answer. Now, this is important to remember when things start to go south a few years later. But for now, this is the high point of the entire Bernie Ebbers story. He remarried in 1999. WorldCom shares reached an all-time high of $64.50, giving WorldCom a market cap of $180 billion. Ebbers is being hailed as the Sam Walton of telecom.

[00:16:46] He has a net worth of $1.4 billion. And most people believe now that with the MCI deal closed, the focus would be on integration. As one financial journalist wrote, Ebbers had to learn to run what he has built. But Ebbers' whole raise on debt for the previous 15 years had been growth through acquisition. And it seems like he just can't help himself. He either just got addicted to deal-making,

[00:17:15] or maybe he just didn't want to knuckle down and actually get into the nuts and bolts that a boss needs to do when running a successful company. And so in October 1999, WorldCom announced another enormous merger, this time with Sprint, and it will create a business for around 30% of the entire domestic market. But almost immediately, regulators signal that they're not going to allow it. And this is a big problem because without another big acquisition,

[00:17:46] WorldCom has no real growth story to sell to Wall Street. And now as we move into March 2000, you guessed it, I've said it before, the dot-com bubble bursts, and with it, the growth of the telecom sector. And I'm reminded of one of Warren Buffett's great sayings. Only when the tide goes out do you discover who's been swimming naked. Well, the tide is truly going out and WorldCom has been heavily exposed

[00:18:14] because underneath all of the deal-making, and because Ebers has been so focused on just buying instead of actually running the company, WorldCom is a mess. Like one great example, it has more than 40 separate billing systems all inherited from the 40 or so different companies that it bought. It's deep in debt. Its revenue growth is slowing, and even more crucially, WorldCom's falling share price

[00:18:40] is creating a huge personal financial crisis for Ebers. And this is crucial. By this stage, he had borrowed more than $400 million from banks and pledged his WorldCom shares as security. And he'd used this borrow money to buy like so many things, 500,000 acres of Canadian timberland, a huge ranch, a trucking company, a yacht building business, and even a minor league hockey team. And like as the economy slumps, these are not the kind of assets

[00:19:10] that can be quickly turned back into cash. So, as WorldCom's share price starts to fall, the banks, they start demanding more security. And Ebers, he can't simply sell millions of his shares to repay them because that would push the price down even further. So, he's obviously under huge pressure to keep the share price high. And what happens next depends on whose side of the story you want to believe. So, on October 26th, 2000, the company is about to miss

[00:19:39] its earnings target. So, Scott Sullivan, the CFO, he orders money that had been set aside elsewhere in the accounts to be moved around, making the quarter look much better than it really is. Now, there is pushback from within the accounting team, but Sullivan, who claimed to be under pressure from Ebers, tells his team we have to hit our numbers. But he also assures them that this is only a temporary thing and it won't happen again. But of course, it does happen again. Throughout 2001

[00:20:08] and 2002, the company is hemorrhaging cash and in 2001 alone, Sullivan hid $3.8 billion in operating costs and he manufactured a fake net profit of roughly $1.4 billion. And Ebers continues reassuring Wall Street that WorldCom's revenues are growing strongly. Behind the scenes, the supposedly independent analyst our friend, Jack Grubman, he's actually helping Ebers prepare his answers

[00:20:38] for calls with investors. And during one of these calls, Ebers actually says, we have solid investment grade debt ratings and we are free cash flow positive. Let me be clear, we stand by our accounting. But even while Ebers is saying this, some of Grubman's own colleagues in his bank were writing emails that there was absolutely no reason to own this stock. It's a dog. Now, Grubman is later charged with issuing biased,

[00:21:08] misleading research reports to fraudulently pump telecom stocks. And while he settled the civil charges out of court without admitting or denying any wrongdoing, he was forced to pay $15 million in fines and he received a lifetime ban from working in the securities industry. Now, it's also worth remembering that the Enron scandal blew up in 2001 and some investors and regulators they're suddenly looking very closely at heavily indebted companies like WorldCom

[00:21:38] with complicated accounts. And as a result, the shares fall below $4 and in April 2022 the board forced Ebbers out of the company. Ebbers went on a local TV station after being removed and said I feel like crying but I am 1000% convinced in my heart that this is a temporary thing. Now, the crisis accelerates. WorldCom's debt is downgraded to junk, it's removed from the S&P 500 and an internal audit team

[00:22:08] starts digging into the accounts and they discover the fraud. Sullivan is sacked, the share price drops to just $0.08 and on July 21st, 2002 WorldCom files for bankruptcy and with $107 billion in assets it is the largest bankruptcy in American history at that time. Thousands lose their jobs, their pensions, their savings and the fraud eventually grows to more than $11 billion. In March 2004 Ebbers was indicted on nine felony charges.

[00:22:38] Scott Sullivan pleads guilty and agrees to testify against Ebbers. And the entire case, it really comes down to two completely different versions of what happened. Sullivan tells the jury that he spoke privately with Ebbers about the improper accounting entries and that Ebbers knew exactly what they were doing. According to Sullivan, the instruction from Ebbers was very simple and it's the same message that he passed on to his accounting team, we have to hit our numbers. Now, Sullivan,

[00:23:07] he's not exactly the perfect witness. He's already admitted to his own role in the fraud and is testifying against Ebbers with a view, of course, to getting a reduced sentence. He also admitted during the court case that while working at World Cup, he had used cocaine and marijuana. And although Sullivan gave Ebbers copies of key documents, prosecutors couldn't produce a single email, voicemail or piece of correspondence showing that Ebbers knew about the fraud. So next, Ebbers takes the stand

[00:23:37] and he completely contradicts Sullivan. He says that he trusted Sullivan entirely and that Sullivan never once told him that any accounting entry was improper, unsupported or illegal. As Ebbers said on the stand, he has never told me he made an entry that wasn't right. If he had, we wouldn't be here today. And, Ebbers, he falls back on the same defence that he had used throughout his career. He was the dealmaker, the salesman. He was not the technical or financial expert.

[00:24:07] But, the prosecution has recordings of Ebbers speaking to the media and to Wall Street investors and of course in those recordings he talks very confidently and in very specific detail about WorldCom's revenues, about his expenses, its debt, its future financial performance. Now, of course, he could have done all that without actually understanding any of the figures. But, prosecutors are also able to point to Ebbers' reputation as someone who kept a really

[00:24:36] close eye on costs. Like, he noticed relatively minor overspending and yet at the same time he claimed not to notice internal reports showing that revenue growth was going down and that line costs were moving by as much as 900 million dollars in a single month. So, the government's argument is that even if Ebbers didn't understand exactly how the fraudulent entries were being made, he knew or at least must have strongly suspected

[00:25:06] that there was a huge difference between WorldCom's real performance and the numbers being given to investors. And rather than ask questions, he deliberately chose not to find out. So, in legal terms, that's called conscience avoidance or more commonly it can be called willful blindness. And then the prosecution also point to the timing. The fraud began in autumn of 2000 at almost the exact same time that the banks

[00:25:35] started demanding repayment of the more than 400 million dollars in personal loans that Ebbers had secured against his WorldCom shares. So, the government argues that this gave Ebbers an enormous personal motive to keep WorldCom's reported profits and its share price as high as possible. Now, before the verdict, Ebbers returns to his church in Mississippi and at the end of the service, he walks to the front of the hall and tells the congregation I just want you to

[00:26:05] know you aren't going to church with a crook. But, the jury disagrees. Ebbers is found guilty on all nine counts. And look, when you're pitting one person's word against another, it's always tricky. I don't trust Sullivan. I can't really put my finger on it. I just don't trust him. And based on an excellent article from the Washington Post, neither did most of the jury believe him. But overall, I do side with the

[00:26:35] jury in that I just can't see how Ebbers didn't know about the fraud. That June, Ebbers agreed to surrender almost everything he'd left. That was about $40 million to a trust for the victims of WorldCom's collapse. And then in July 2005, he was sentenced to 25 years in prison. I mean, that was a harsh sentence. Sullivan got five years. A year and a half later, while he's in jail, Ebbers' wife files for divorce and inside prison, his health

[00:27:04] deteriorates, he develops heart disease, he becomes blind, and he eventually suffers from dementia. In December 2019, after serving 13 years, a judge granted him compassionate release. He returned home to Mississippi and died just over a month later, on February 2nd, 2020. He was 78 years old. The Ebbers and the WorldCom story, it's one that we see repeated again and again. A company grows massively during the boom years and everyone, the company,

[00:27:34] the press, Wall Street, me, we all become convinced that it can do no wrong. It's a kind of a group think. The company keeps growing with the market and eventually becomes so big that even if a crash happens, we believe they'll be big enough to weather it. But two things of course worked against WorldCom. First, to use that famous Mike Tyson line, everybody has a plan until they get punched in the mouth. Well, the dot-com bubble bursting is WorldCom's punch in the mouth. The company has just one plan,

[00:28:04] keep growing through acquisition, and when that stops working, there's nothing to fall back on. And this kind of ties into the second problem, which is that Ebers simply wasn't a good CEO for a big company like that. I mean, he was brilliant at building WorldCom, buying other companies while the times were good, but the business itself was built on the shakiest of foundations. Like, a good CEO has to plan for the bad times. Ebers didn't. And then whether he

[00:28:34] actively encouraged the fraud or simply let it happen, the responsibility is on him for what came after that. It's a story like we've seen so many times before, and we will be seeing it again pretty soon, I'm sure. And whatever your thoughts on Ebers and WorldCom, I think it makes for a brilliant story. And that brings us to listeners' emails. And this one comes from Adam, and he had some great story suggestions, two of which weren't on my list. So these were Lee Caching,

[00:29:04] the Hong Kong billionaire who founded Hutchison Holdings, and Gianluci Aponte. This guy has a net worth of $44 billion through his ownership of MSC Shipping Company. They are two fantastic suggestions, Adam. Thanks so much, and thanks also for listening. And remember, if you have any comments, any corrections, or any story you'd like me to cover, email me at info at gbspod.com. All the best, folks.