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Financial woes entangle telecoms

By Andrew Backover, USA TODAY

A year ago, the telecommunications industry was as hot as it gets. Now, it's a shambles.

In the past 5 months, telecom carriers and equipment makers have axed more than 130,000 jobs worldwide, with tens of thousands of the cuts in the USA.

Dealmaking has died. This year, telecom mergers and acquisitions totaled $6.6 billion — down from the quarterly average of $60 billion for the past 3 years. Spending has cooled. Major carriers are expected to cut capital expenditures by about 2.1% this year and 6% next year. That's an awesome drop from last year's 34% increase in capital spending from 1999.

After an amazing 5-year run of non-stop growth, spending and investment, the telecommunications industry has hit its first lull of the Internet Age. A slowing economy and overzealous expansion has left the sector with a glut of competitors chasing too few customers. Profits are eroding. The effects ripple far and wide. Tuesday, long-distance giant AT&T reported a net loss of $366 million in the first quarter, compared with earnings of $1.74 billion a year ago. Its reversal of fortune has sparked a plan to split into three stand-alone companies as it attempts to win back investors. JDS Uniphase, citing a sales slowdown, said it would cut 5,000 jobs on top of the 3,000 it announced this year, wiping out nearly 30% of its workforce in two swipes.

The worst may be yet to come. The industry is undergoing a shakeout that has claimed dozens of smaller telecom companies and is expected to claim dozens, possibly hundreds, more in the next several years. And the titans are being shaken, too. Cisco Systems, which makes the guts of the Internet and vaulted for a few days last year to the world's most valuable company, is now shrinking as fast as it used to grow. Lucent Technologies, which reported a second- quarter loss of $3.7 billion Tuesday, is so shaky that investors recently dumped its shares when bankruptcy rumors rocked Wall Street. Nortel Networks CEO John Roth said Thursday, after announcing a first-quarter loss of $385 million, that he won't even guess when his company's situation will improve.

While the sector's woes aren't enough to crater the shaky U.S. economy, or even stop a recovery, it could slow it, economists say. A dearth of new investment by telecom carriers — though the industry accounts for less than 2% of total gross domestic product — turns off the growth spigot for a host of other industries — from equipment makers, such as Nortel, to fiber makers, such as Corning — and Wall Street.

Banks and bondholders extended an estimated $500 billion to the U.S. telecom sector in recent years, and $100 million of that debt is on precarious footing, analysts estimate. For consumers, the implosion could mean disrupted Internet service, higher prices for high-speed Net access, and a longer wait for technology, such as video-on-demand, that was supposed to change their lives. "We are at the top of a very long food chain," says Roth. "The telecom sector pullback has had a major impact."

That's because in recent years, it was doing so much to pull the economy up. While the U.S. gross domestic product grew 5.9% in 1999 over 1998, the telecom industry grew 12.2%, says the Bureau of Economic Analysis. From 1995 to 2000, telecom carriers and equipment makers increased average U.S. employment by 212,400, up 18%, while overall private sector employment grew 13%. "The sector has contributed a disproportionate share of the growth in the U.S. economy," says Graham Wallace, CEO of Cable & Wireless. The seeds of growth The ramping up began in 1996, when the U.S. government started to deregulate the local telephone industry. A wave of start-ups popped out to compete with the regional Bell phone companies, just like the wave of long-distance sellers that went after AT&T following its 1984 breakup. The number of small telecom carriers increased to at least 300 at the peak, from a few dozen in 1996. There are now more than a dozen companies, either based in the USA or with a strong U.S. presence, that have or are building major national and international telecommunications networks. That's up from a handful a few years ago.

The rise of the Internet followed deregulation, creating new opportunities for such things as Internet access and Web-site hosting. Thousands of Internet service providers (ISPs) sprang up. As telecom firms bought into the notion that data, voice and video traffic via big pipes would explode, they started a flurry of building. Money was flush. Hundreds of billions of dollars poured into the telecom sector. Telecom stocks soared, along with tech stocks, giving carriers more money with which to expand. Venture capitalists, who invest on behalf of wealthy individuals and institutions, last year poured at least $19.8 billion into telecom ventures, up 77% from the year before.

"They went to the public markets and said, 'Hey, a tidal wave is coming. Give me the surfboard. Give me the debt. Give me the cash,' " says J.P. Morgan analyst Chris Wolfe. "If only five companies did it, it would be fine. But hundreds did it."

The telecom industry had a compelling story to tell. Personal computers were spreading to one out of two U.S. homes. The Internet was all the rage, and opportunities abounded for telecom networks to carry bandwidth-hungry services, such as streaming video. Market researchers spoke of electronic commerce, including business and consumer, hitting trillions of dollars. The "New Economy" was born, and telecom was its backbone. "How many other industries have an opportunity to go to 100 million households and every business in the United States?" says Ron Vidal, senior vice president of Level 3 Communications, owner of international and national networks. Not willing to say 'enough'

There were plenty of signs that the bubble might burst. Dozens of e-commerce companies weren't even close to making money, yet their stock values soared. The glut of long-distance providers pushed calling costs down more than 13% since 1996. The broadband businesses that long-distance carriers, such as AT&T and Sprint, expanded to make up the difference didn't grow as fast as earlier hoped. Wireless companies started offering free long-distance and cheap calling plans, putting more pricing pressure on traditional phone and long-distance companies.

The frenzy peaked last year when Deutsche Telekom, France Telecom and others vastly overpaid for new wireless licenses in Europe. They now are strapped for cash to build the networks. "No one wanted to stand up in the middle of a party and call it over," says Vidal. Wall Street finally did last year. New capital for dot-coms dried up, pushing dozens of them and their data-driven businesses out of business. Venture capitalists began to shun small telecom carriers and ISPs, many of which wouldn't turn a profit for 5 years. Rhythms NetConnections, which sells high-speed Internet access through digital subscriber lines, topped $110 a share shortly after going public in 1999. It now trades for about 25 cents and may fold. The companies say the sudden switch in investor sentiment caught them off guard. "Wall Street analysts were telling our companies to build, build, build. We didn't worry about a return on investment," says John Windhausen Jr., president of the Association for Local Telecommunications Services. "Then they wanted to see immediate profits and revenues. We weren't able to do that." Now, many smaller carriers are running out of cash. Windhausen estimates that 100 carriers, or 33% of the total, have failed since December. Of the 36 publicly held ones, at least six have filed for bankruptcy protection, including ICG Communications. Half, including Teligent, have share prices under $5. Merrill Lynch analyst Ken Hoexter says that only about a dozen will remain in 2 years. Of the long-haul carriers, Nortel's Roth says only about half may survive. "Over the summer, we'll probably know who is going to make it and who won't," he says.

Woes plaguing the industry: Too much debt. The U.S. telecom industry borrowed nearly $245 billion from banks since 1996, making it the third-largest borrower among industries last year, according to Thomson Financial Securities Data (TFSD). In 1996, the industry ranked 12th. Communication companies in the USA also issued nearly $270 billion in bonds during that time to raise cash to build data centers, lay fiber cables and buy computer servers and software, TFSD says. "We've downgraded a ton of (telecom) debt over the past couple of years," says Dennis Saputo at Moody's Investors Services. AT&T has been shedding assets, including some of its cable TV systems, to reduce its net debt from $56 billion at year's end to $47.5 billion today. Lucent is considering selling its $2 billion fiber-optic cable business.

Big telecom equipment providers were also quick to extend credit to customers. At last count, Cisco, Nortel and Lucent had committed to $13.4 billion in such financing and debt guarantees. How much of that is in trouble is unclear. But Nortel said last week that 90% of its future financing will be to established companies, up from 85% previously. Lucent has promised a similar tightening of credit standards. No wonder: Every week, another customer seems to head for Chapter 11 bankruptcy protection. Last week, two telecom firms filed: Winstar and eGlobe.

Buried in inventory. Overall, the entire technology sector, including telecom, accounts for 8% of U.S. manufacturing inventories and 3% of overall inventories. The auto industry's inventory troubles were a far more serious problem for the economy, which slowed sharply when automakers cut production over the winter, economists say. But for individual telecom and telecom-related companies, the inventory overhang is serious. Cisco last week was forced to write off $2.5 billion in excess inventory. The glut of capacity extends to the carriers themselves. The flurry of building has left most of them with too much. Roth says demand will catch up with supply in about 4 months, but Wall Street analysts are less sure. Already, carriers are seeing customers tighten. Sprint says customers are adding fewer phone lines and buying less equipment. Last week, it reported first-quarter net income from operations fell nearly 30% from the same period a year earlier. It is rethinking plans to spend more than $6 billion this year on capital investments. The ripple widens

As companies such as Sprint spend less, the pain spreads. Credit Suisse First Boston last month lowered earnings estimates for equipment supplier JDS Uniphase because Nortel, which sells to companies such as Sprint, represents 15% of JDS' sales. JDS is one of dozens of companies to cut jobs in response to the slowdown. "Those thousands of people laid off will be spending less," says Wallace, the Cable & Wireless CEO. As more firms fold, the rollout of high-speed Net services will slow. If consumers don't have faster access to the Net, they're less likely to need more powerful PCs to handle the same tasks they do now with dial-up modems. As of last year, only 12.6% of the USA's 43.2 million online households had high-speed Net access through cable TV, phone, wireless or satellite connections, according to research firm IDC. "That trickles down to (chipmaker) Intel and Microsoft," says Chad Fleischman, senior vice president at Columbia Management. Even banks are being squeezed. In March, Bank One listed telecom as one of the problem areas in its loan portfolio. In December, the Bank of England warned that "risk arising from the substantial increase in exposures to the telecom sector" contributed to a riskier financial environment. But David Wyss, chief economist for Standard & Poors' DRI, insists the debt level is "not a big deal" for the banking sector because it is in good health and most of the troubled credit is junk bonds. At the bottom of the food chain are customers. And they're being hit, too. When financially ailing NorthPoint Communications shut down last month, stranding 100,000 customers, thousands of businesses lost the super-fast Internet access it provided — and that cost them in productivity.

SBC Communications, the USA's No. 2 phone firm, has scaled back its $6 billion high-speed Net expansion and raised the price of the service by 25%. Last year, Qwest halted a plan to deliver cable TV through phone lines because there wasn't enough investment return. AT&T says it might leave the local phone business because it's not profitable, cutting competition. "Consumers will lose the choices, innovation and lower prices that competition can bring," says Ron Binz of the Competition Policy Institute. "This is a recipe for trouble." Contributing: George Hager

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-- (perry@ofuzzy1.com), April 25, 2001