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Telecom bust reverberates loudly

Struggles send ripple effects through entire economy

By Rebecca Blumenstein, Scott Thurm, and Greg Ip

THE WALL STREET JOURNAL

July 25 - For a few months last year, even the rust-belt city of Scranton, Pa., seemed poised to enter the booming New Economy, thanks to a nationwide frenzy of telecommunications-industry investment.

FIBER-OPTICS GIANT Corning Inc., its orders overflowing, had taken over a struggling aerospace plant and announced plans for a major expansion and 2,500 new jobs. “For one month last October, we dipped below the national unemployment average for the first time in 30 years,” Austin Burke, president of the Greater Scranton Chamber of Commerce, recalls wistfully. “Then, everything seemed to fall apart.”

Its sales collapsing, Corning two weeks ago said it would close the half-finished plant, firing 600 workers. On top of other “old economy” plant closures, the move has sent Scranton’s unemployment climbing and morale plummeting. “They came in here and promised us the world. And they just blew us out of the water,” says Christine Wilczewski, laid off after nine months at Corning.

Scranton is a microcosm of how telecom’s boom and bust has whipsawed the entire national economy. Although the telecom sector is relatively small, it played an outsized role in driving the economy to its recent heights — and now telecom’s surprising fall is a major factor holding back recovery. Already, tens of thousands of well-paying jobs have been lost in the industry, surpassing the higher-profile carnage of the dot-com bust, and far more are likely to disappear this year.

The impact reverberates far beyond telecom carriers and their equipment suppliers, down through a food chain that reaches into almost every corner of the economy, from metalworking shops in San Jose to commercial real estate in Dallas. The telecom bust has also wiped out almost $2 trillion in stock market wealth, losses which are damping household spending. Billions more stand to be lost on defaulted telecom debt, which is beginning to affect borrowing costs for other companies.

Other sectors such as computers have played their part pulling down the economy in the past nine months. Indeed, a major contributor to economic cycles is that businesses spend enthusiastically on buildings and equipment when times are good and cut back sharply when times are bad. But the communications sector is going through far more than a cyclical downturn. Oceans of cheap capital and competitive one-upmanship drove telecommunications and Internet service providers to build far more capacity than realistic forecasts of demand could justify. Now, many of those companies are bankrupt, or close to it, and investment in communications equipment has shriveled.

SPENDING SWING

The swing in spending from blistering growth to near collapse has had a huge impact on the economy’s trajectory. Though telecom-equipment spending came to $124 billion last year, a relatively modest 1.2% of gross domestic product, it accounted for almost a quarter of the drop in economic growth from the first half of last year to the first half of this year, estimates James Glen, an economist at Economy.com in West Chester, Pa.

Telecom has roiled the financial markets even more than the real economy. Internet stocks got the hoopla, but the communications sector actually created, and destroyed, more wealth. Many investors thought established and profitable companies such as Cisco Systems Inc. and WorldCom Inc. that were building the Internet infrastructure had intrinsic value that flash-in-the-pan dot-coms lacked. At their peak in March last year, the local, long distance, and wireless companies and telecommunications and network-equipment makers boasted a combined market value of $2.7 trillion, according to Westport, Conn., research firm Birinyi Associates. They have since shed $1.7 trillion of that, accounting for more than 90% of the net loss in stock wealth in that period.

Job cuts are just getting under way among telecom service providers and equipment makers, but a parade of layoff announcements suggests they will accelerate. So far this year, these companies have announced about 225,000 job cuts, according to a tally by this newspaper. That’s equal to a fifth of all announced layoffs in the U.S. recorded by ISI Group, a New York economic-research firm. Just Tuesday, Lucent Technologies Inc. signaled it will be cutting as many as 20,000 more workers, on top of 19,000 layoffs and buyouts already announced, bringing the total to nearly a third of its work force.

Not all announcements are followed up with actual job cuts, and some of these layoffs are occurring outside the U.S. Even so, the total announced cuts in telecom already far surpass the 134,000 in the dot-com sector logged by The Industry Standard magazine since December of 1999. And unlike the case with Internet layoffs, which tended to be concentrated in a handful of major metropolitan areas, the telecom cuts affect a wider swath of the country.

Nestled amid northeastern Pennsylvania’s coal-rich hills, Scranton has seen a steady stream of manufacturing plants move abroad in search of cheaper labor. Local leaders worked hard to lure new employers before finally finding what seemed to be their future in telecommunications. Corning took over a plant from Northrup Grumman Corp. in April 2000 and in December announced a $150 million expansion to accommodate a total of 2,500 workers. Across town, FiNet Technologies, another maker of fiber-optic parts, was so busy that workers couldn’t take weekends off — and were strongly encouraged to work four hours of overtime a day. More than 400 were hired as FiNet moved its plant across the city to a location double in size. Suddenly, by late last year, Scranton had two fiber-optics plants under construction and workers couldn’t be hired fast enough.

“People were stopping me on the street asking how they could apply to Corning,” says State Sen. Bob Mellow. State job sites touted fiber optics as “the backbone of the new economy.” Scranton finally seemed to be on a roll as economic development plans to lure other white-collar jobs and redo its downtown took off.

PLAYING SOLITAIRE

Then the slump hit. Ed Boyarsky could see the trouble coming from his post in the Corning plant. Initially, his team was building amplifiers used to carry voice and data traffic over long-haul networks for Lucent, and when it ran into trouble, the business switched over to Nortel Networks Corp. When Nortel, which has just reported a 51% drop in North American sales from a year ago, hit a wall, the few orders that kept trickling in were from Ciena Corp. In between, workers had so little to do they were playing solitaire on their computers.

Ms. Wilczewski lost her job two weeks ago. To make matters worse, her husband will lose his job of 30 years this month when a unit of France’s Thomson Multimedia SA moves a television-picture-tube plant to Mexico. “After both of us working 30 years, both of us are unemployed,” says Ms. Wilczewski, 46 years old.

Corning officials say they had little choice but to close the plant after a sudden slowdown in demand. “We regret letting people go. It was a break of trust,” says Wendell Weeks, president of Corning Optical Communications, which represents the company’s entire telecom business. Meanwhile, FiNet has cut its work force to about 150.

Companies such as Corning failed to foresee the slump in part because each is just one link in the food chain. At the top stand businesses and consumers who buy services from local and long-distance phone companies, Internet service providers and long-haul fiber-optics carriers. Many of those carriers came into existence in the past few years with grandiose ambitions financed by mountains of cheap capital from bond and stock investors. Newly risk-averse investors have largely stopped funding the upstart carriers’ costly plans, forcing some into bankruptcy and others to conserve cash to avoid bankruptcy. With competitors on the ropes, even healthy, established carriers are cutting back.

WorldCom of Clinton, Miss., is paring capital spending by as much as 30% this year from last year to as little as $7.5 billion because much of its network is finished. WorldCom and other carriers were the major customers of equipment makers such as Lucent, Nortel, and Cisco, who have announced steep job cuts.

But the brand-name manufacturers are just the most visible casualties. Each of their products is stuffed with semiconductors, connectors, power supplies and other gear from a dozen or more suppliers, who also are reeling. Contract manufacturers such as Solectron Corp. and Flextronics International Ltd., which actually build most telecom gear for the name-brand firms, have announced 45,000 layoffs so far this year. “It was just a ripple effect. Cisco started downsizing and we worked for them,” says 51-year-old Vickie Strong, laid off on May 15 from her job as a production supervisor at a Flextronics plant in San Jose.

The contract manufacturers, in turn, rely on lesser-known suppliers, such as JPM Co. of Lewisburg, Pa. Founded in 1949 as a maker of parts for RCA record players, the company grew explosively in the late 1990s making electronic connectors and wire harnesses for the communications industry. Two years ago, JPM was named one of the fastest-growing companies in Eastern Pennsylvania. But sales declined 19% in JPM’s most recent quarter, and it is closing factories in Columbus, Ohio and San Jose, Calif. George Dito, 41, was laid off from JPM’s San Jose factory in January, after six years making wire harnesses for $13.05 an hour. He’s submitted more than 100 job applications since then, but has been offered only part-time, no-benefit positions such as “pouring coffee.”

In California and other high-tech hotbeds, the communications boom pulled numerous low-tech companies into its orbit. Galgon Industries is a Fremont, Calif., sheet-metal company that makes equipment cages for Cisco and Lucent. From 1993 to 2000, Galgon sales grew tenfold, according to Jeffrey Foreman, vice president of operations. But business is off 30% this year, and two weeks ago, Galgon cut salaries 10%. That means $80 less take-home pay a week for John Reyes, a 33-year-old toolmaker, who’s already watched Galgon lay off 175 workers this year.

VACANT ‘HOTELS’

Real estate also joined the food chain, and the telecom slump is adding to the surge in commercial and industrial vacancy rates in many metropolitan markets. Brokerage Grubb & Ellis Co., Northbrook, Ill., estimates that real-estate developers created more than 50 million square feet of telecom “hotels” to hold switching equipment and computers that serve up Web pages in the past three years. Some 39% of that was vacant at the end of June. Archon Group, a subsidiary of New York investment bank Goldman Sachs Group Inc., erected or renovated telecom hotels in six cities, says Rusty Perry, Archon’s director of acquisitions. But centers near Dallas, San Francisco and Washington have no tenants, and the Philadelphia building is only 15% leased. “We had just started construction or redevelopment when the market started drying up,” says Mr. Perry.

Throughout this food chain, financial backers have committed huge sums of money, and they are among the biggest losers of the bust. UBS Warburg high-yield bond analyst Aryeh Bourkoff estimates at the end of last year, total high-yield, or “junk” bonds issued by U.S. telecom and cable companies amounted to about $120 billion. At its peak, telecom equaled about 40% of the entire high-yield market. About half of that is now trading at 50 cents per dollar of face value or less, he says, which means investors think it carries a high risk of default. It’s almost impossible for existing non-investment-grade telecom companies to issue new bonds, forcing many to slash capital spending further in an effort to stay afloat.

Telecom’s woes are also beginning to spread to other borrowers, as investors shy away from the whole class of riskier bonds. In late June, for instance, American Greetings Corp., a greeting-card company had to alter a bond issue and pay a higher yield because of the fallout from the telecom sector on the high-yield market, market participants say.

Banks are far less exposed to telecom today than they were to commercial real estate a decade ago, when bad real-estate loans threatened the banking system’s solvency and produced a credit crunch that crippled the entire economy. That’s because so much of the lending has been through bond markets, and the banks that have lent to telecom companies are far better capitalized and have sold off some of the credits to other institutions, such as certain mutual funds. But many took part in risky loans to telecom companies that could cause a hit to earnings. Mr. Bourkoff says some of those loans are trading in the secondary market “at between 20 and 40 cents on the dollar, which is very unusual for secured assets.”

Beyond banks, the telecom inferno has managed to burn a surprising array of other participants. Pathnet Telecommunications Inc., a Reston, Va., company aiming to bring high-speed Internet services to smaller cities, filed for Chapter 11 bankruptcy protection April 2. According to regulatory filings shortly before the action, some of Pathnet’s $350 million in bonds were held by mutual funds offered by Goldman Sachs and Lutheran Brotherhood, a nonprofit fraternal group that offers financial services to Lutherans. Other creditors include Cisco, Lucent and Nortel, all of which lent Pathnet money to buy their products; and suppliers like Ozzie’s Technical Services of Scottsdale, Ariz., which inspected fiber lines. Pathnet’s venture backers, who will likely lose everything, included a petroleum-pipeline company as well as a bank and venture-capital firms.

The telecom boom touched so many companies, workers and investors that its bust is going to have reverberations for some time. For example, though consumer spending is still growing, it has slowed significantly from last year, in part because of the steep losses on telecom-related stocks by people like Bill Sand.

At age 80, the AT&T Corp. retiree is coping with a monthly loss of about $1,000 from his holdings in his former employer alone. During the boom times, Mr. Sand used the money to pay his mortgage and utility bills. With AT&T stock now down two-thirds from its high and its dividend slashed, “we just don’t have the freedom that a consumer might have on spending on nonessentials,” says Mr. Sand, of St. Charles, Ill.

Because the telecom sector is glutted, the normal forces of recovery such as lower interest rates will likely do little to revive investment. Last week, Fed Vice Chairman Roger Ferguson said in a speech the Fed’s interest-rate cuts should stimulate consumer spending, but acknowledged the impact on high-tech investment could be limited. “Conditions in short-term money markets, by themselves, are unlikely to induce substantial further investment, for example, in the long-haul fiber network,” he said.

Telecom service providers and equipment makers employ two million people, Economy.com’s Mr. Glen estimates. Three quarters are employed by service providers, primarily the regional Bell companies, where job levels have been relatively steady. The remainder are in manufacturing. Unpublished Labor Department figures show a loss of only about 25,000 jobs there so far this year, but that’s almost certain to grow.

The unemployment rate, still historically low, will help a lot of those people find new jobs, but probably at less money. Mr. Glen says telecom salaries average between $57,000 and $75,000, compared with the national average of $43,000. As recently as last Christmas, Ms. Strong, the Flextronics production supervisor, was working overtime. Now, she estimates that 80% of the 900 people who worked with her are gone. The two adjoining buildings once had 13 production lines running 24 hours a day; now there are two lines working one shift. Now, she’s considering taking a clerical job at a nearby police department paying roughly half her $60,000 Flextronics salary.

Copyright © 2001 Dow Jones & Company, Inc. All Rights Reserved.

-- (M@rket.trends), July 25, 2001

Answers

And the administration is continueing to push for social security monies to be given to people to invest. Do those people have any kind of brain that accepts data and uses logic? At age 80, the AT&T Corp. retiree is coping with a monthly loss of about $1,000 from his holdings in his former employer alone. During the boom times, Mr. Sand used the money to pay his mortgage and utility bills. With AT&T stock now down two-thirds from its high and its dividend slashed, “we just don’t have the freedom that a consumer might have on spending on nonessentials,” says Mr. Sand, of St. Charles, Ill.

Especially since most people who will have to depend on social security have no knowledge of how the stock market works in the first place.

-- Cherri (jessam6@home.com), July 25, 2001.

Uh... Cherri,

Yes, if you put all your marbles in the stock market and don't have the time to sit on it for 10 or more years - then you can get hammered by a downturn if that is your investment strategy. But allowing the taxpayer to invest part of their social security allocations does NOT mandate they be put in stocks. That's a good story for spin, but other investment options are available, as you are probably aware.

And of course, the average citizen is stupid and needs to be 'taken care of', or at least that has always been the mantra of government bureaucrats.

-- libs are idiots (moreinterpretation@ugly.com), July 26, 2001.