Digex expects a boost from WorldCom

Majority shareholder coming out of Chapter 11

April 22, 2003|By Stacey Hirsh | Stacey Hirsh,SUN STAFF

The technology sector's downward spiral wasn't the only force Digex Inc. had to reckon with last year. It also had to face the backlash from the bankruptcy and accounting scandal of its majority shareholder, WorldCom Inc.

But with the telephone giant set to emerge from Chapter 11 in the fall, Laurel-based Digex is expecting a boost in business from WorldCom.

"There can be nothing but positive for Digex with WorldCom coming out of bankruptcy," said Andrew M. Schroepfer, who follows Digex and is president of Tier 1 Research in Minneapolis.

Digex, a corporate Web-hosting company, relies heavily on sales leads from its reseller, WorldCom. At the end of the fourth quarter, 255 of Digex's 619 customers had come through WorldCom.

But after WorldCom's widely reported accounting scandal and Chapter 11 filing in July, Digex saw a drop in the number of leads coming in, said George Kerns, president and chief executive of Digex.

Kerns said that started to change shortly after WorldCom named Michael Capellas its chairman and chief executive officer in mid-November. WorldCom filed its reorganization plan with U.S. Bankruptcy Court in the Southern District of New York last week and said it would change its brand name to MCI.

"Now we're seeing already a bit of an uptick in there," Kerns said, "and I would hope that as every day goes by, and more and more people are seeing that WorldCom is going to emerge from bankruptcy, that we'll see more and more leads for our services."

Digex's ties to WorldCom go back to July 2001, when the phone company acquired Digex's largest shareholder, Intermedia Communications. With that acquisition, it gained a 60 percent stake in Digex.

Except for the fourth quarter of 2002, the Laurel company had borrowed money from WorldCom every quarter since their relationship started. In the third quarter of 2002 Digex borrowed $15 million that WorldCom owed it in reseller invoices before filing for bankruptcy.

Since going public in July 1999, Digex has never been profitable. In February, its stock was delisted from the Nasdaq SmallCap market. It had been moved there from the Nasdaq national market in September after shares dropped below $1 last April and remained there. The shares are now traded on the over-the-counter bulletin board.

Shares closed yesterday at 41 cents, up 3 cents.

In November, Digex said its board of directors retained a Boston investment bank to explore "strategic options," including a sale. The company has been through two rounds of layoffs, bringing its staff to 785 from 1,393 about a year ago.

"The restructuring that Digex did, when we saw what was taking place at WorldCom plus what was going on in the economy at large, we basically got our expenses in line with our revenue," Kerns said.

Kerns said the company has reached some milestones in 2002. Its earnings before interest, taxes, depreciation and amortization were out of the red as of the third quarter of 2002. Also in 2002, Digex's cash flow from operations for the year was positive for the first time since the company went public.

Digex has also changed its business model. Before, the company would always buy equipment when new customers signed up for Web-hosting. Now, sometimes the customer buys the equipment, and sometimes Digex reuses equipment it already owns or helps its customers lease equipment from another company.

"In terms of the actual business model, it is already showing signs of life and signs of growth," said Schroepfer, the Tier 1 Research analyst.

One factor that will affect Digex's future is what happens to $60 million that Schroepfer estimates WorldCom owes Digex as part of a reseller agreement the two companies signed in 2001, Schroepfer said.

Because of its bankruptcy status, WorldCom may try not to pay Digex the money or not to forgive $60 million in debt that Digex owes WorldCom, Schroepfer said. Whether or not Digex gets the money will determine whether Digex itself has to go through a bankruptcy filing, Schroepfer said. However, he does not anticipate a Digex bankruptcy.

Schroepfer expects Digex to survive and to continue its relationship with WorldCom.

"That means, if you're thinking about using Digex, you can now be more confident that if you like having MCI as a partner, that they will be partners in some fashion," Schroepfer said.

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