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UVA-F-1175

MCI COMMUNICATIONS CORP.: CAPITAL STRUCTURE THEORY

On a cold winter morning in February 1996, Katzu Mizuno stood admiring the panoramic view of New York Harbor. In his first five months in New York as a first-year associate for Lynch Investments, Mizuno had been pleasantly surprised to have some free time to explore the “Big Apple.” During this period, he had found an apartment, been to Madison Square Garden for a Knicks game, attended the symphony at the Lincoln Center, and had made frequent trips to a sushi bar in his neighborhood. The tranquility of the moment ended, however, with an urgent phone call from his boss, Anna Curti.

Earlier that morning, MCI Communications Corporation, a long-time client of the firm, had called seeking advice about establishing a program to repurchase some of its outstanding common stock. As Exhibit 1 shows, throughout most of 1995, MCI’s stock had been a sluggish performer in an otherwise buoyant market, and management sensed a growing restlessness on the part of shareholders. At a recent meeting of the board of directors, discussions had centered on repurchasing some of the company’s stock as a means to enhance shareholder value. One long- time director, Gavin Philips, pushed hard to finance the repurchase by increasing MCI’s debt financing. He argued that this action would send a bold signal to the market about the future prospects of the firm. To be effective as a signal, Philips suggested that the company would need to increase its debt-equity ratio from its current level of around 40% to “more or less twice that.” He said, “Even at that debt level, MCI’s debt-to-cap would be moderate relative to the industry.” He estimated that such action would require MCI to issue approximately $2 billion in additional debt. Other directors, concerned that the increased debt burden might impede the company’s current capital-expansion program, argued for a less-extreme approach. They favored an open- market purchase program instead. Under that option, the company would announce its intentions to repurchase its stock from “time to time” but only as corporate funds allowed. This course of action, therefore, did not call for any increase in debt.

On hearing the directors’ concerns, a senior vice president of MCI, William Duran, called Curti to seek advice on the repurchase and, in particular, whether debt financing would be advisable. Duran also indicated that since the board hoped to disclose the details of its plan to improve shareholder value by the end of next week, it would be necessary to get back to him as

This case was prepared by Susan Chaplinsky, Associate Professor of Business Administration, and Robert S. Harris, Professor of Business Administration, University of Virginia. Support for this work came from funds provided by both the Darden School Foundation and the TVA. This case is drawn entirely from public data. All persons and events recounted are fictionalized to facilitate the teaching objectives of the day. Copyright © 1997 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 3/04. ◊

soon as possible. Curti responded quickly: she assigned a second-year associate, Lance Alton, to gauge the possible interest in any debt securities that MCI might choose to issue, and she asked Mizuno to examine the consequences of substantially increasing the firm’s use of debt. She instructed both of them to report their initial findings to her the following day.

Mizuno decided to compare MCI with its major competitors in long-distance telecommunications. However, he grew somewhat alarmed when his...
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