AT & T Case Summary

(1)What (if any) are the problems confronting the company?
MCI was committed to extending the reach and capacity of its network, and this needed to have external financing. However, facing new business environment, MCI is not sure whether their new financing to drive growth would be appropriate. In addition, MCI is looking for which way will be most effective financing. (2) How did the problems arise?
Antitrust settlement between AT&T and the U.S Department of Justice in January 1982 had significantly altered the economic landscape for MCI. Due to the settlement, AT&T broke up their long distance telecommunications division by early 1984. This gave MCI the opportunity and threat at the same time. As an opportunity, MCI might
be able to increase its growth because AT&T is going to compete on equal quality-of-service terms with MCI. As a threat, MCI will lose its cost advantages allowing AT&T’s competitive flexibility.

(3) Does the management adequately understand the problems and their causes?
Yes. They are on the right track that is more external financing for investment is in need.

(4) What (if any) solutions to the problems is the management considering, and how good it is??
Regarding future financial policy, case hasn’t provided any solutions but explained the need for additional financing. There was the word from CFO, Wayne English, “Availability of funds the paramount consideration’; cost was “secondary”. However, as MCI doesn’t know how FCC antitrust settlement of AT&T will change the business environment, and how AT&T will come up with their service pricing.

(5) What and why would you do?
Judging from the case, this industry has huge fixed cost, and success of business highly depends on how MCI leverages it. Market share in this industry seems to be critical in terms of generating profit. In addition, AT&T antitrust shows, the customers are unlikely move to other carrier companies if they decide which company’s services they are going to use. Exhibit 9A, baseline forecast of anticipated MCI operating characteristics, measured its revenue multiplying gross interstate long distance market and market share. It shows market share directly leads to generating sales, and profit from the customers. Even if there is slight uncertainty, it’s better to move quickly being aggressive, expanding their market share first. This means MCI needs more financing to respond AT&T’s business
strategy.
However, like case illustrated, there’s still uncertainty about their business because its profit is highly depending on AT&T’s access charge, and its future movement. hardship to predict following fixed and working capital. Calculating free cash flow under favorable and unfavorable scenario, both cases show negative free cash flow signaling more external financing in needs.
However, from exhibit 8, MCI’s debt ratio seems to be little bit high compared to industry standard. The debt ratio shows 55%, even if it has the smallest revenue. Moreover, compared to other companies, MCI’s Price earnings ratio range is showing pretty high. It’s because of the diluted EPS if convertible debts are converted. MCI seems to rely on external capital financing highly, showing 895.0 millions of long-term debt, and 765.6 millions of stockholder’s equity. Especially, in case of long-term debt, debenture bond portion is showing 427millions among 895 million, and rest of part seems to be convertible bond. Seeing only these figures, financing general company seems to give huge burdens.

Moreover, the debentures that MCI issued before seem to be unfavorable condition. Exhibit 6 shows that issued at 16.80% with 84.71% of face value in April 1981, and 15.17% with 85.625% of face value. Those two are the highest interest rates, because MCI doesn’t have enough collateral. With discounted issuing value MCI have similar or more debt ratio, even if its revenue and net income, asset shows lower.
Interest expenses were also increased from 26 to 75. From exhibit 7, MCI’s debenture issued before 2~3 years ago shows high interest rate. Currently, MCI’s interest rate is showing lost compared to former issues. In this situation, MCI’s former financial policy can be huge guide. MCI has used financial instruments efficiently, having enough room for flexibility. Convertible preferred stocks with call option issued in 1975, 1979 and 1980 gave huge flexibility along with company growth blocking cash drains when they needed new investment. However preferred stock with call option should be less considered as company has no more tax carry forward benefit.