WPCD 2 ZBeJ0YHP LaserJet 5P/5MP (HP)XN\  PXPX0Í ÍX0Í ÍQuick 1. . XN\  PXP(9 Z6Times New Roman RegularX@*f9 xX 4Times New Roman ItalicXN\  PXP(9 Z6Times New Roman RegularXA\  PP(9 Z6Times New Roman Regular4\  PP(9 Z6Times New Roman Regular2:B3|x   @Page  of @#@*f9 xX#    #XN\  PXP# #A\  PP#Affidavit of David Shapiro, Keilin & Co. LLC CC Docket No. 97211#4\  PP# Affidavit of David Shapiro  1. Name and Qualifications  1. I am a Principal of both Keilin & Co. LLC, and KPS Special Situations Fund, L.P. As a Principal of Keilin & Co. LLC, a New York based investment bank that represents organized labor in corporate transactions, I have been involved in a wide variety of acquisition and restructuring transactions including the employee buyouts of Algoma Steel and UAL Corp., the restructurings of Navistar International, Northwest Airlines and the New York Daily News. 2. I and my partners, Eugene Keilin and Michael Psaros, recently raised nearly $200 million in two private equity funds that will invest in troubled middle market companies. The KPS Funds expect that employee participation will be a key component of all of its transactions. 3. I graduated from the University of Michigan with High Honors in History and received an MBA with a Specialization in Finance from the University of Chicago Graduate School of Business. 2. Purpose and Overview 4. The Communications Workers of America (CWA) asked me to examine and analyze the financial statements of WorldCom, MCI and their closest competitors in the telecommunications industry. I have relied on the following information for my analysis. 5. (A) Income statements and balance sheets of MCI and WorldCom. These financial statements are available in various public filings submitted to the Securities and Exchange Commission (SEC).  6. (B) Income statements and balance sheets of MCI and WorldComs major competitors in the telecommunications industry. These companies are: AT&T, Bell Atlantic, Bell South, GTE, Frontier, LCI, SBC Communications, and Sprint. These public financial statements are also available in filings submitted to the SEC. Keilin & Co. LLC stores most of this information in a database used to analyze the telecommunications industry. I have used this database to create the accompanying table comparing the financial attributes of WorldCom and MCI to that of its competitors. I refer to this table in my findings. 7. (C) Proforma income statement and balance sheet of the merged MCIWorldCom. This is from the joint proxy statement for the special meeting of shareholders to approve the merger filed on January 22, 1998, with the SEC as Amendment No. 3 to Form S4. 8. (D) Valuation analyses provided by WorldComs and MCIs financial advisors, Salomon Smith Barney and Lazard Freres, respectively. These are also from the joint proxy statement. 3. Facts and findings: 9. (A) The balance sheet of WorldCom is unlike any other telecommunications firm. It is particularly unique due to the large amount of Goodwill & Intangibles it carries as assets.  Generally Goodwill and Intangibles (G&I) is recognized only when a business is acquired at a price in excess of the fair market value of its net assets. That portion of the difference between book value and the purchase price that cannot be attributed to the market value of specific assets is generally categorized as G&I. 10. Prior to the MCI acquisition, WorldCom had the highest level of goodwill of its peer group in both absolute and relative terms. As shown in the accompanying table, WorldCom had $13 billion of G&I on its balance sheet as of September 30, 1997. AT&T, the largest telecom in terms of total assets and revenues, had only $8.3 billion in G&I, followed by SBC which had $3.2 billion; GTE $3.0 billion; MCI $2.4 billion and BellSouth $1.8 billion. 11. Prior to its acquisition of MCI, WorldComs G&I represented 62.5% of its total assets. By way of comparison, an index of other major telecommunications companies (AT&T, Bell Atlantic, BellSouth, GTE, Frontier, LCI, MCI, SBC, Sprint and WorldCom) reflected an industry average G&I of only 11% of total assets. Among the major companies, including AT&T, SBC, GTE, and MCI, goodwill as a percent of total assets was respectively 14.7%, 7.8%, 7.4%, 9.6%. WorldComs tangible assets are only slightly more than onethird of its total assets. In contrast, 90.4% of MCIs assets are tangible assets and 85.4% of AT&Ts assets are tangible. 12. Similarly, WorldComs G&I represents a significantly higher percentage of shareholder equity than any other telecommunications firm. Shareholder equity is the net worth of a company after subtracting liabilities from assets and represents the book value of the shareholders investment in the corporation. WorldComs G&I equals 97.3% of its shareholder equity, while G&I for the rest of the industry, excluding WorldCom and MCI, averaged 22.5% of shareholder equity. For the major firms, G&I as a percent of shareholder equity ranges from a high of 39.1% at GTE to a low of 20.9% for MCI. 13. The high level of G&I will result in a reduction of reported earnings in the future as the goodwill and intangibles are amortized (charged against earnings) over an extended period of time. This expense is not tax deductible. 14. The asset structure of MCI and WorldCom are rather different. In contrast to WorldCom, MCIs balance sheet reflects relatively little Goodwill and a high level of tangible assets. As of September 30, 1997, MCIs G&I was only 9.6% of total assets and 20.9% of its shareholder equity. MCIs tangible net shareholder equity was 36.2%, third only to BellSouth and Sprint. 15. However, the new consolidated pro forma financial balance sheet of WorldCom and MCI will bear almost no resemblance to the old MCI. Instead, its key balance sheet ratios will be virtually identical to the preacquisition WorldCom with even less net tangible shareholder equity. The new MCI WorldCom will have $44 billion in G&I representing 61.6% of total assets.On a proforma basis prior to incorporating the impact of the Brooks Fiber and CompuServe transactions, which will further increase G&I and marginalize tangible net shareholder equity G&I will be 99.6% of total shareholder equity. Its tangible assets will represent only 38% of the entitys total assets. The industry average is 93%. 16. In fact, the new MCI WorldCom will carry on its balance sheet a disproportionate share of total industry G&I and virtually none of the industrys tangible net shareholder equity. The new MCI WorldCom would have 72% of the total telecom industry G&I, just 11% of the industrys tangible assets, and only 0.3% of the industrys tangible net shareholder equity. 17. (B) A new MCIWorldCom will have a greater debt service load stemming from the all cash payment to British Telecom (BT) for its 20% stake in MCI. WorldCom will have to undertake an additional borrowing of $7.4 billion to finance a $6.9 billion cash payment to BT, plus other estimated transaction costs of $510 million which includes a $465 million fee paid to BTYJoint Merger Proxy Statement, Amendment No. 3 to Form S4, SEC, p.93.Y. The resulting incremental annual interest expense stemming from the merger will be $481 millionXBased on WorldComs estimated incremental borrowing rate of 6.5%.X. As a result, there will exist an added financial burden on the new MCIWorldCom to meet its interest obligations due to restructuring which comes about due to the acquisition. This incremental debt burden will restrict its free cash flow that it may have otherwise spent on building telecommunications infrastructure. Furthermore, the companys ability to finance expansion will be more closely linked to its lending rate. Each percentage point increase in WorldComs lending rate will translate into an additional $74 million in annual interest expense. 18. MCIWorldCom will be under intense pressure to achieve either revenue increases or cost savings that exceed the expense that will be recognized for both G&I and interest expense. 19. (C) WorldCom has acquired several companies in all stock transactions. Before WorldCom acquired MFS Communications on December 1996, it had 420 million shares outstanding. Currently WorldCom has 930 million shares outstanding. If the MCI acquisition is consummated, WorldCom will have nearly doubled the number of shares outstanding to 1.8 billion. Thus in less than two years, WorldCom will have printed some 1.3 billion shares of new stock for its acquisitions with the expectation that WorldCom will generate superior future earnings growth. WorldCom reported a net loss of $5.50 per share in 1996. For the nine months ended September 30, 1997, WorldCom reported $0.25 earnings per share. 20. (D) WorldComs P/E ratio is far above other telecoms. The stock market has supported WorldComs high P/E ratio based on expectations of future earnings growth. WorldComs P/E ratio is 96, second to LCI which has a P/E ratio of 117.)As of March 9, 1998. ) In contrast, AT&T has a P/E ratio of 21 and GTE has 18. Sprints P/E ratio is 31. MCIs P/E ratio is 47. The higher the P/E ratio, the greater the expectations investors have in the future earnings generating capacity of the company. A high P/E ratio can only be sustained if WorldCom management succeeds in meeting investor expectations of earnings growth well above the telecommunications industry average. 4. Conclusion ::21. Based on my analysis and facts presented above, in my opinion, a merger between MCI and WorldCom will create an entity that will be under extreme pressure to deliver on promised market share growth, cost reductions and other synergies in order to bolster earnings and offset the amortization of a very substantial amount of goodwill and intangibles and incremental interest expense from transactionrelated borrowings. Such pressure may cause the new MCIWorldCom to focus on high margin, high growth segments of the industry at the expense of lower margin, lower growth segments.  I hereby swear, under penalty of perjury, that the foregoing is true and correct, to the best of my knowledge.    David Shapiro