The Intermedia(ry)

WorldCom buys CLEC to gain control of Digex Like a toddler at Christmas, WorldCom last week eagerly ripped open its expensive present and immediately began playing - with the packing paper.

At least that's the way it may have seemed to outsiders. Officially, WorldCom spent $6 billion to buy Intermedia, a competitive local exchange carrier (CLEC) with holdings concentrated primarily in the Southeast. But WorldCom officials immediately emphasized that the real target in the deal was not the core assets of Intermedia but its controlling interest in Digex, a Maryland-based Web-hosting company.

"First and foremost, this is about Digex," said WorldCom President and CEO Bernard Ebbers in his opening statement to analysts after the Intermedia announcement.

Digex fills a significant void in WorldCom's quest to fulfill its "generation d" mission of becoming the standard-bearer among the world's data carriers. WorldCom's current Web-hosting capabilities provide only "elementary" co-location services, not the sophisticated suite of managed services offered by Digex, Ebbers said.

"We were going to have to [enter the managed services arena] anyway," said Scott Sullivan, WorldCom's chief financial officer. "This just short-circuits it by 12 to 18 months."

With Digex, WorldCom plans to offer business customers Web-hosting services over its global network, Ebbers said. Digex will remain a separate, publicly traded company.

"Eventually, we see [that] WorldCom's Web-hosting [division] will be merged into Digex," Ebbers said.

For Digex, the deal is expected to remove some of the limitations of being under the umbrella of Intermedia. Although Intermedia was billed as the largest independent CLEC, it has experienced tough financial times recently. In fact, Intermedia placed Digex on the market after reporting disappointing second quarter earnings in July, citing Digex's high market value and its drain on Intermedia's capital.

While funding Digex's rapid growth became a burden to Intermedia, WorldCom officials embrace the idea of paying for the Web-hosting company's expansion - and giving Digex access to WorldCom's worldwide sales force and global network.

"We believe we bring a lot to the table for this company," Sullivan said. "This is a real opportunity to better fund [Digex's] growth initiatives. We'll probably accelerate their capital spending."

While WorldCom officials focus their attention on the company's 55% financial stake and 94% voting interest in Digex, Intermedia's core assets appear to be an afterthought. That's probably because WorldCom plans to sell much of the CLEC's assets for strategic, financial and regulatory reasons.

News of the deal was not welcomed by all Digex shareholders, many of whom anticipated a big payday amid speculation that Exodus and Global Crossing's GlobalCenter were willing to pay more than $100 per share.

"Digex shareholders kind of got screwed," said IDC analyst Melanie Posey. "But they should have thought about that before they invested. Nothing was going to get done without Intermedia's blessing."

Certainly Intermedia officials were not complaining. After all, WorldCom agreed to pay about $3 billion for the company - an almost 60% premium at $39 per share - and to assume Intermedia's $3 billion indebtedness.

"I think, in the last month or so, Intermedia's people just decided, `Let's cash out,'" Posey said. "And that's sort of what happened."

On its own, Digex was worth more than Intermedia, Posey said. But selling Digex would have left Intermedia facing a future without its greatest assets, she said.

"But Exodus is not a telco, so they wouldn't want a CLEC," Posey said. "And Global Crossing just got rid of its telco unit."

This opened the door for WorldCom, which had the money to buy Intermedia, the ability to incorporate wanted assets and the willingness to sell unwanted assets for cash. WorldCom will evaluate Intermedia during the next several weeks before deciding how to use its assets, said Brian Brewer, WorldCom's senior vice president for marketing.

Buying Intermedia/Digex is WorldCom's first significant move since the well-chronicled collapse of its proposed merger with Sprint. WorldCom officials say it is the first step in the company's effort to refocus resources in high-growth areas.

"Certainly the regulatory bodies sent a very clear message about limitations," Brewer said. "We think [the Intermedia deal] shows our resolve to move down the road."

Not being allowed to complete the Sprint deal left WorldCom without a mobile wireless play. With the costs of entering the wireless market increasing daily, it appears to be even less likely that WorldCom would pursue another wireless venture soon.

Compared with wireless price tags, buying Intermedia/Digex is a bargain, and Web hosting offers a greater chance for near-term profitability than 3G wireless, Brewer said.

But WorldCom still would be interested in making a wireless play under the right conditions, he said. As wireless companies expend so much cash on licenses, they may seek a company such as WorldCom to help build out the expensive networks, he said.