Intermedia's swan song

WorldCom to sell CLEC assets The back story to WorldCom's purchase of a majority stake in Digex is the fate of parent company Intermedia Communications, a one-time leading independent competitive local exchange carrier that finds itself in the unusual position of being an unwanted asset.

Not surprisingly, in announcing the acquisition, WorldCom executives said it would sell 60% to 80% of Intermedia's core assets within 12 months of the deal's closing. WorldCom took on $3 billion in debt as part of the deal, and could use some of the proceeds to reduce the deficit.

Certain to be on the block are the eight local markets in the Southeast where WorldCom and Intermedia own overlapping operations. In addition, most of Intermedia's customers are small and medium-sized businesses, making them a less attractive fit for WorldCom's strategy of targeting big business customers, said Michael Renegar, an analyst at CE Unterberg, Towbin.

"There may very well be markets where we have synergy and can achieve the same objective vs. a sale," said Scott Sullivan, WorldCom's chief financial officer. "But more than half the assets will be looked at in terms of placing [them] outside the company."

Buffeted by mounting losses, $2.4 billion in long-term debt and a dispute over provisioning with BellSouth, Intermedia was not only looking for a way to unlock the value of its Digex stake, but also was seeking an exit strategy for its core local and long-distance voice and data network operations.

"We had reached our peak at our current level and needed additional scale and scope, and a global network," said an Intermedia spokesman. "WorldCom needed Digex, but Intermedia also needed WorldCom."

On July 11, Intermedia warned that its second quarter revenue would fall 10% to 15% below analyst expectations. Intermedia later reported revenue of $247.4 million and negative EBITDA of $70.9 million. Although data, Internet and Web hosting revenue was up 53% to $129.8 million in the second quarter, local access and voice revenues declined about 26% to $80.7 million from $101.6 million in the second quarter of 1999. Analysts also were projecting losses of $15.01 per share for 2000 and $14.44 per share in 2001.

Intermedia attributed its financial woes to a reduction in reciprocal compensation rates and a slowdown in business due to provisioning problems with the company's UV.net, frame relay and Internet products. A pending lawsuit filed in a Florida U.S. District Court accuses BellSouth of not meeting performance commitments. The suit seeks compensatory and punitive damages as well as $100 million in past due fees for BellSouth traffic terminated by Intermedia. Eighty percent of Intermedia's local lines are in BellSouth's territory.

"The capital markets are making it very difficult for everyone," Renegar said. "With three misses in three quarters, a lot of the investors were fed up with the management team. [Intermedia] could have continued as an ongoing concern, but new board members and strategic investors were not willing to wait that long to turn it around."

WorldCom will be strongly motivated to dispose of the Intermedia assets within one year so that it will not have to consolidate the losses from them. If the assets are not sold, the Intermedia deal would dilute WorldCom's cash earnings by about 13%.

Intermedia could have sold its 55% equity interest in Digex and plowed the proceeds back into its communications business. However, selling only the Digex stake would have triggered obligations for Intermedia to pay down some of its long-term debt, said Trent Spiridellis, senior research analyst at Banc of America Securities. Any potential buyer would have had to kick in a significant cash sum to cover the debt obligation, limiting the potential universe of buyers, Spiridellis said.

Despite the emphasis on the Digex assets as the "crown jewel" of the deal, Intermedia does possess some core operations that are attractive, Spiridellis said. One of these is Advanced Buildings Network, a $90 million business with 290 DSL access multiplexers deployed in 670 buildings in 17 markets. The business unit also has access rights to an additional 13,500 buildings.

Intermedia also boasts a solid frame relay and ATM business and owns 60,000 fiber miles in 15 metropolitan areas, most in Florida.

Bernard Ebbers, president and CEO of WorldCom, said his company could potentially use a capacity agreement with Williams Communications that Intermedia signed in April 1998 to carry WorldCom customer traffic. "The pricing at Williams should be very attractive - it's a very flexible contract," Ebbers said, "and it does not specify routes to be used."