Funds Hit Again as WorldCom Crumbles

U.S. mutual fund managers, already smarting from losing bets on trashed stocks like Enron Corp. and Tyco International (TYC), took another punch Wednesday when telecommunications giant WorldCom (WCOM) revealed a $3.8 billion accounting scandal.

Shares in the No. 2 long-distance carrier disintegrated before trading was halted, dropping to 9 cents from 83 cents at Tuesday's close. Losses mounted for fund managers, especially those overseeing telecommunications portfolios.

Funds that buy telecommunications stocks, the market's former high-flyers, are this year's worst performers, down an average 38.68 percent as the telecom industry struggles under mountains of debt, excess capacity and a slowdown in spending.

WorldCom's admission that it overstated cash flow by nearly $4 billion over the last five quarters blindsided money managers dealing in bonds of distressed companies, many of whom had snapped up some of WorldCom's $30 billion in debt in recent months.

"Capitalizing what ought to be expenses, it's sort of like getting kicked in the stomach," said Martin Whitman, whose Third Avenue Value fund owns about $100 million in WorldCom debt. "You really don't expect that."

He said his average cost for the bonds was about 20 cents on the dollar, a few cents above the mid-teens where the debt was trading Wednesday.

Whitman, who described Third Avenue as "newcomers" to WorldCom debt, may yet come out ahead on his investment. But analyst Joe Galzerano, who covers the high-yield debt market for CIBC World Markets, said damage to bond holders could be widespread.

"It's a disaster," Galzerano said, noting that WorldCom's debt was held by many investors.

"Thirty billion is a tremendous amount," he said. "You've got it in investment-grade, high-yield, distressed funds. It's held across the entire spectrum."


As bad as the outlook was for many bond investors, funds holding WorldCom stock were in worse shape, investors said.

"Now that the bonds are trading at around 13 cents on the dollar the stock investments are basically worthless," said Wilbur Ross, who made his name as a buyout magnate on Wall Street and now runs a hedge fund through his investment firm WL Ross & Co.

Mutual fund powerhouses like Alliance Capital Management LPand Wellington Management Company LLP and Oppenheimer Capital LP were nervously awaiting news, as were some insurers and smaller value-oriented investors who had hoped WorldCom's fortunes would improve as the U.S. economy rebounded.

According to Thomson Financial's ShareWatch Web service, Alliance held 322 million WorldCom shares as of a May 31 filing, more than any other institutional holder. It is believed the shares are mainly in "value" portfolios managed by Alliance's Sanford C. Bernstein unit.

Wellington owned 147 million shares as of March 31 and Oppenheimer held 104 million, according to ShareWatch Web.

An Alliance spokesman had no immediate comment. Spokesmen at Wellington and Oppenheimer declined to comment.

Alliance shares were off $1.90 or 5.6 percent to $32.25 in late afternoon trading on the New York Stock Exchange. It was also one of the biggest holders of bankrupt energy firm Enron Corp. and troubled conglomerate Tyco International Ltd..


While WorldCom's revelations cut deep into the pockets of average investors, some hedge funds may actually win.

Known for selling stocks short at the first signs of trouble, some hedge funds are said to be making good money as WorldCom's stock screeches lower.

"We shorted the common stock and went long the bonds," Ross said, noting his fund bought debt this morning when it was trading at 13 cents to the dollar. "There are billions and billions of true value even with this accounting situation," Ross said.

Third Avenue's Whitman said debt holders could come out ahead in a bankruptcy scenario.

"In a reorganization we would end up the principle common stock holders," Whitman said

But CIBC's Galzerano said it was too early for bond holders to declare any kind of victory.

"There's going to be some value, but who knows what that value will be. We don't know if these are the right financials and it's difficult to value because of the churn," he said. "It's a moving target."