Headline: Glorious hopes on a trillion-dollar scrapheap

Dan Roberts explains how reckless optimism has led to bankruptcies, job losses and an awesome glut of capacity

Source: Financial Times, 4 Sept 2001

URL: http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT3HX8NZ7RC&live=true

Down by the decaying dockyards, in an anonymous industrial park east of London, the telecommunications industry is suffering its final indignity. Every morning, lorries arrive with refrigerator-sized cabinets of electronics. The plastic bubble-wrap designed to protect them from the Essex drizzle cannot obscure the names on the cabinet: Nortel, Ericsson, Lucent and Cisco, the stars of one of the most remarkable bull markets in history.

Not that the protection is necessary these days. Shields Environmental, which this year expects to receive 6,000 tonnes of unwanted gear, tries to strip and sell as many of the parts as it can from the telecoms equipment. But a large telecoms operator has gone bust on average every six days for the past six months and the second-hand market is saturated.

Hence many of the cabinets will be taken apart by hand for disposal. Each, once worth millions of dollars, will yield a smattering of precious metals and other scrap, some toxic components and a lot of plastic, which is sent to nearby incinerators for burning.

It is all part of a $1,000bn bonfire of wealth that has brought the world to the brink of recession.

Even level-headed captains of industry have been sucked into the flames. Lord Simpson and Sir Roger Hurn, who resigned on Tuesday as chief executive and chairman of Marconi, the UK telecoms equipment group, are only the latest in a long line of executives to have gambled everything on the telecoms revolution - and lost.

The elimination of 2,000 jobs that accompanied their departure will have a lasting impact on the economy of UK industrial towns such as Liverpool and Coventry. But even Marconi's downsizing is tiny compared with the tens of thousands of jobs disappearing every week from larger equipment manufacturers such as Lucent and Nortel.

In popular imagination, the seismic event of the past four years remains the dotcom mania. Its rise featured ex-models grabbing the public eye with high-profile website launches and geeky young men in baseball caps winning millions in paper wealth. Its fall has been the subject of books and films exposing shattered egos and greedy excess.

Yet the more important event was a telecoms bubble that far exceeded the dotcom debacle. Its story remains largely untold - even though the sound of the bubble's bursting is still echoing around the world's economy.

Failed websites and internet retailers may each have wasted a few tens of millions of dollars before going bust but, according to the European Information Technology Observatory, spending on telecoms equipment and services in Europe and the US amounted to more than $4,000bn between 1997 and 2001. Between 1996 and 2001, banks lent $890bn in syndicated loans, according to Thomson Financial. Another $415bn of debt was provided by the bond markets and $500bn was raised from private equity and stock market issues. Still more came from profitable blue-chips that drove themselves to the brink of bankruptcy orbeyond, in the belief that an explosive expansion of internet use would create almost infinite demand for telecoms capacity.

The global financial system became addicted to fuelling this bonfire. Nearly half of European bank lending in 1999 was to telecoms companies. Moody's, the credit agency, estimates that about 80 per cent of all the high-yield, or "junk", bonds issued in the US at the height of the boom were to telecoms operators. Five of the 10 largest mergers or acquisitions in history involved telecoms companies during the boom.

The enduring legacy of all this money is a glut of "bandwidth" - the capacity to transmit volumes of data and the basic raw material of a ll communications networks. This glut is so great that if the world's 6bn people were to talk solidly on the telephone for the next year, their words could be transmitted over the potential capacity within a few hours.

Analysts estimate that only 1 or 2 per cent of the fibre optic cable buried under Europe and North America has even been turned on, or "lit". Some people point out that the remaining "dark" fibre needs additional investment to activate it and that it therefore does not represent a surplus. But that is of little comfort to the beleaguered telecoms industry. There are enough new ways of squeezing extra capacity out of existing, lit fibre to have caused a collapse in bandwidth prices.

With new techniques to send multiple wavelengths of light down a single fibre, up to 160 separate "colours" of light can now be used to transmit data down a single strand of glass. Most modern networks use just a tenth of this potential today - or less than a thousandth if dark fibre is included. A similar overcapacity exists in undersea links, where each new Atlantic cable adds as much bandwidth as all the previous infrastructure put together. And mobile phone companies have committed more than $200bn in Europe alone to boost the bandwidth of their wireless internet services without any proof that consumers will use it or that the technology will work.

The collapse of the financial bubble has been felt in numerous ways, from the $60bn in telecoms loan defaults so far this year to the thousands of recent redundancies among investment banks. More than 300,000 jobs at telecoms equipment manufacturers have gone within six months, with perhaps a further 200,000 in components suppliers and associated industries.

The stock market value of all telecoms operators and manufacturers has fallen by $3,800bn since its peak of $6,300bn in March 2000. To put this into context, the combined loss in value on all of Asia's stock exchanges during the Asian financial crisis of the late 1990s was only $813bn.

The tiny sums that can be salvaged from the wreckage of those companies that the financial markets will no longer support reveal the scale of the devastation. Most of the 31 telecoms operators that have filed for bankruptcy in the past six months spent hundreds of millions of dollars building networks. Creditors that try to liquidate those assets are finding they are now worth only a minute fraction of that amount.

In 1997, Motorola launched a $5bn fleet of communications satellites called Iridium, a project that collapsed with barely a handful of customers. The satellites were going to be left to crash back to earth, until this year the US Department of Defence stepped in to salvage them and a consortium bought the fleet from the bankruptcy court - for $25m.

Research by Prof Edward Altman at New York University suggests that investors owning junk bonds issued by telecoms companies that have since defaulted recovered an average of 11.9 cents in the dollar during the first half of the year, compared with 24.7 cents the year before.

Richard Coates, a specialist in corporate recovery at Ernst & Young in the UK, estimates that on average less than 10 per cent of the original cost of building networks is recovered when court-appointed receivers try to sell those assets. As a proportion of the total cost, including spending on non-network infrastructure such as staff and office equipment, it is lower still. According to receivers, the average recovery rate for the half-dozen European telecoms operators that have recently completed the bankruptcy process is between 2 and 3 per cent.

"It's going to get progressively more difficult to find buyers and people are now looking instead at mothballing equipment in the hope that the climate will improve and somebody will one day find a use for this stuff," says Mr Coates.

It could be a long wait. Ionica, a British operator that used radio equipment to provide wireless phone services to homes and small offices, was one of the first alternative networks to go bankrupt in 1998. Three years later, much of its equipment is still stuck on roofs because recycling it would not cover the cost of taking it down.

Big companies are at last beginning to recognise how much money they have wasted. This year Nortel Networks and JDS Uniphase, two of the largest equipment manufacturers, wrote down the balance sheet value of assets they bought at the height of the boom. They revealed some of the biggest losses in corporate history.

Sonera, the Finnish telecoms operator that was one of a dozen or so European companies to spend E120bn ($109bn) on third-generation mobile phone licences, last month gave back one of its licences for free rather than add to the E4bn it had spent to date.

The telecoms mania has cost the world a fortune. Economists will always argue over what constitutes waste, particularly as a lot of people have grown rich from the bonanza. Combining the various ways of measuring investment that has been written off with the top-down analysis of spending and stock prices gives a sense of the damage. Consider that: Overcapacity in the most capital- intensive part of the industry is running at more than 98 per cent; The asset recovery rate for those companies that have been wound up is between 2 and 3 per cent; Those companies that are still trading have seen their stock market valuations fall by an average of 60 per cent. Hence perhaps a quarter of the money spent during the bubble could be regarded as wasted investment. Or, to put it another way, probably $1,000bn has gone up in smoke.

Some still regard this as a period of creative destruction without which we should never have had the benefits of the internet and improved communications technology. Such optimists believe that the telecoms mania will lead to the development of a new stream of healthy profits in the future. But the derisory sums raised in the sale of assets by receivers suggest that little of this technology is wanted now, even at a tiny fraction of what it cost to produce.

At least two questions arise from this debacle. How could so many clever people have got it so sensationally wrong? And how has the global financial system been able - so far at least - to absorb the loss of $3,800bn in stock market wealth and the waste of perhaps as much as $1,000bn in real cash?

-- Andre Weltman (aweltman@state.pa.us), September 05, 2001

Answers

The last sentence is a complete enigma to me too. It has me totally stumped.

-- Wellesley (wellesley@freeport.net), September 05, 2001.