Today, Bernard Ebbers will begin his 25-year sentence for the implosion of WorldCom. Based on federal sentencing rules, he will stay in prison at least until 2028. Given that Ebbers is 65, this is likely to be a life sentence.
Then again, Ebbers was at the helm of one of the biggest accounting fraud schemes, which has led to far-reaching regulations, such as Sarbanes-Oxley.
Ebbers will certainly have a lot of time to think about his misdeeds. But, we investors should also take some time to reflect. In other words, what can we learn from all this?
Let's look back at Ebbers' history. In fact, there is a new book, Business Fairy Tales, which has a comprehensive chapter on the WorldCom saga. The author is Cecil Jackson, a USC finance professor.
Actually, WorldCom started in the early 1980s with a good idea: With the break-up of AT&T, there was a huge opportunity for savvy companies to provide better long-distance phone services.
Ebbers realized that to succeed his company needed to quickly increase his customer base and build a scalable network. The fastest way to do this was to buy other companies. But, with little cash in the bank, what could he do?
Basically, Ebbers could use stock to get deals done. Of course, this would only work if the stock price continued to increase. So, through the go-go 1990s, Ebbers used his stock to engage in a myriad of acquisitions. But to keep the growth moving, he needed to buy bigger and bigger companies.
However, by 1999, there were only two massive telecom companies left for WorldCom to buy: AT&T and Sprint. Well, WorldCom made a play to purchase Sprint, which was a whopping $129 billion deal.
The problem: the federal government blocked the acquisition because of antitrust concerns.
From then on, it was downhill for WorldCom; the Ponzi game was finally over. But, according to Jackson, there are some important lessons for today's investors:
Goodwill: If a company is purchased for a price that is above its net asset value, the difference is accounted for as goodwill. In the case of WorldCom, the company accumulated nearly $50 billion in goodwill.
What can investors focus on? Jackson says that you need to be wary if goodwill is increasing much faster than earnings. This may be a sign that the comany's fundamentals are deteriorating and that there are accounting games with the financial statements.
Reserves: A buyer may take restructuring charges when it buys companies. These are often referred to as "one-time" charges. However, if a buyer makes these moves on a frequent basis, it is a warning sign.
Sales vs. Assets: If sales are decreasing as assets are increasing, this many be a sign that a company is engaging in financial shenanigans. That is, the company may be turning expenses into assets – which artificially inflates profits.
Tom Taulli is the author of various books, including the Complete M&A Handbook and operates InvestorOffering.com.
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