McLeodUSA: Twice Bitten

Channel Partners

August 1, 2005

5 Min Read
McLeodUSA: Twice Bitten

Once beloved by Wall Street, McLeodUSA Inc. is in hot water again. The telecommunications carrier is pursuing a strategic partner or sale of the company and has disclosed it may be forced to seek protection from its creditors while its auditor, Deloitte Touche LLP, has raised substantial doubt over McLeodUSAs ability to continue as a going concern.

McLeodUSA has been down this rough road before. It emerged from bankruptcy three years ago, eradicating $3.3 billion in high-yield debt while refueling on capital through its biggest investor, Forstmann Little & Co.

Dedicated to refocusing within 25 states, the company based in Cedar Rapids, Iowa, divested $1 billion in assets in 2002. McLeodUSA also consolidated facilities, reduced capital expenditures, shed unprofitable services and took other actions to improve its operations. Those actions, however, havent led to sales growth or moved the company into the black.

In fact, revenue at McLeodUSA has been falling for the last three years while its losses have been accumulating. The company more than doubled its net loss last year ($624.5 million) while its revenue declined from $869 million in 2003 to $716.2 million last year.

Like dozens of other competitive carriers that raised billions on Wall Street after the Clinton administration opened the local phone markets to competition, McLeodUSA has been unable to fulfill its promises to investors.

With shares trading at 14 cents early this summer, the company had a market capitalization of just $27.8 million.

How did it come to this? In filings with the Securities and Exchange Commission, McLeodUSA cites a host of factors, including the challenges of competing with bigger, more-established firms in a territory covering the Midwest, Rocky Mountains and other Western states. The company foresees greater difficulties in the wake of industry consolidation combining big phone companies like AT&T Corp. and SBC Communications Inc.

With the recent merger announcements in the industry, we believe that the large telecommunications providers likely will become even more aggressive upon the closing of these transactions, further challenging our ability to grow revenue,  McLeodUSA stated in a SEC filing.

Analysts say inexperienced management is not the root of the problem at McLeodUSA, a company which broke into smaller markets than its peers like Cedar Rapids, Milwaukee and Spokane, Wash.

The McLeodUSA management is really very strong. They are not people without very significant experience in the space, says Farooq Hussain, founder and principal of Network Conceptions LLC, a research and consulting firm. Youd think they should be doing all right.

McLeodUSA has been one of the better managed CLECs with kind of a pragmatic rational approach to what theyre doing, adds Nancy Kaplan, vice president of global consultancy ADVENTIS Corp. McLeod is actually fairly well run [but] they cant get the penetration in the marketplace anymore.

What may have challenged McLeodUSA, says ATLANTIC-ACM analyst Aaron Nutt, is a partial focus on the residential market.  Most big competitive carriers have sought to woo businesses, which could be paying hundreds or thousands of dollars a month for telecommunications services.

McLeodUSA did not return phone calls seeking comment.

McLeodUSA now is focused on small and mid-sized businesses, Kaplan says, but the competition in that market has heated up among the nations largest carriers. She says it is difficult for a company like McLeodUSA to compete with the regional Bell operating companies and biggest long-distance carriers.

Clearly, some challenges facing McLeodUSA are not unique to the company. The competitive wireline industry has been responsible for dozens of high-profile bankruptcy filings and failures over the last several years. More recently, the stock prices of regional and national competitive carriers have tanked on the heels of disappointing results.

Hussain says the competitive phone model based on switched local and longdistance voice service is busted, caused partly by the widespread adoption of wireless usage and slugfest between the biggest long-distance carriers to drive down rates.

Results at McLeodUSA partly support that assessment. The company attributed a $33.1 million year-over-year decline in first-quarter revenue to lower longdistance rates, a continued decline in total customers and a mandated reduction in access rates by federal regulators.

John Malone, president and CEO of The Eastern Management Group, a research and consulting firm, says there is no end in sight to the challenges facing the competitive telecom industry. Investors continue to wring their hands … No one sees a clear end to the challenges, Malone says. We may be dealing in this environment for another two, three, four years.

Malone says there are about 70 facilities-based competitive carriers in the United States, and he anticipates the number could decrease by 50 percent over the next two years due to consolidation.

But for McLeodUSA, finding a buyer wont be a cinch. Its not going to be another phone company [that would be interested in the purchase], and I dont know what you do with the assets when you pick it up because theyre not worth much, Hussain says of McLeodUSA and some other carriers that have faced difficulties. Whoever buys them is not going to pay very much.


ADVENTIS Corp. www.adventis.comATLANTIC-ACM www.atlantic-acm.comAT&T Corp. www.att.comDeloitte Touche LLP Management Group, The www.easternmanagement.comMcLeodUSA Inc. www.mcleodusa.comNetwork Conceptions LLC www.networkconceptions.comSBC Communications Inc.

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