Meltdown

Telecoms tycoons gambled entire firms on a hi-tech rush to wire Europe for super-fast internet links. They lost - at a cost of billions and their own jobs. A report by Jamie Doward

Sunday September 9, 2001 The Observer

They called it the Golden Triangle. And for a while its seemingly alchemical properties blinded everyone to its risks. The awe-inspiring multi-billion-pound network of fibre optic pipelines linking Europe's biggest cities was cutting-edge technology. Built in the early Nineties it was the information super-highway made real, the dream data-carrier of the future. It was the global village realised, a world in which we would all be connected by a single central nervous system.

But the Golden Triangle should have been called the Bermuda Triangle. It eventually sucked billions of pounds of investors' money down the drain.

Today it is a physical testament to unfettered greed and deeply flawed thinking. The 600 pairs of fibre optic cables, which link such cities as London, Paris, Brussels and Frankfurt, lie forlornly in the ground, waiting for a revolution that never came.

Despite staggeringly high predictions of the way we would all zip huge amounts of data around at high speeds on the internet, it turns out that we need only a single pair of cables to satisfy Western Europe's entire present demand for data traffic.

Yet many telecoms companies had thought otherwise and risked everything, and now they are staring bankruptcy in the face. The banks and investment houses which lent billions of pounds to any firm with even a vague connection to the telecommunications sector, not to mention the shareholders who bought into the dream at vastly inflated prices, have been left shell-shocked.

Given the rosy claims made only a couple of years ago, their dismay is understandable. One report in 1999 by the accountancy firm Price waterhouseCoopers predicted that the value of all the world's companies would grow from $20 trillion to an almost unimaginable $200trn in less than a decade due to the internet revolution.

'The years 2000-2002 will represent the single most profound period of economic and business change that the world has ever seen, not unlike the industrial revolution but much faster - at e-speed,' the report gushed.

Dozens of chief executives who were sucked into the mania have paid a huge price. Last week one of Tony Blair's favourite businessmen, Lord Simpson, was ousted as head of Marconi. It was the City's revenge for a botched attempt to turn the firm into a leading maker of internet equipment.

Marconi entered the game far too late. As the economic downturn spread across the globe, companies slashed their orders for kit to update their networks. Marconi was left with products no one wanted to buy.

The change from global giant to corporate wreck has been startling. Two years ago, as telecoms mania gripped the world markets, Marconi's share price towered at £12. On Friday it closed at 29p after one of the most terrifying share collapses in British business history. Last week the company, formerly the massive GEC conglomerate built up under Lord Weinstock, one of this country's most successful businessmen, suffered the ignominy of having its bonds reduced to junk status.

The firm's humiliation will be completed this week when it is expected to fall out of the FTSE 100 index of Britain's leading companies, along with eight other former stock market darlings. The demotion, in a quarterly reshuffle, will take effect on 24 September. Simpson's spectacular failure places him in exalted company. Earlier this year, Sir Iain Vallance, chairman of BT, was forced from office. The Scot's head was the price BT shareholders demanded for helping to bail out the formerly wealthy company. It had been plunged nearly £30 billion into debt by a massive spending spree across Europe and the Far East while the value of telecoms firms was soaring. BT's share price now stands at less than £4. Two years ago it was almost £16.

Some observers now whisper that the highly respected Sir Christopher Gent, chief executive of Vodafone, may be next. His company's value has collapsed from more than £220bn to about £90bn. A question mark also hangs over Alan Duncan, head of Atlantic Telecom, who admitted last week that shares in his firm, which was once valued at more than £2.5bn, may now be worthless.

The question now being asked is how could telecoms mania have run quite so wild? After all, the industry was managed by some of the brightest, most experienced people in British business, unlike the dotcom sector which seemed dominated by inexperienced twentysomethings. Telecoms firms made money, had solid business plans and answered to shareholders. Surely they could not be sucked into such a dangerous game? Yet they were.

'It was all about the pursuit of filthy lucre,' said Camille Mendler, a director of the telecoms consultancy, the Yankee Group. 'Many companies got excited about the internet. But a lot of estimates about how this market would develop were flawed. They looked at the bullish forecasts without thinking about the caveats.'

The scramble to build the cable networks was sparked by old-fashioned competition, as firms rushed to be first to cash in on the internet boom. Stars of the FTSE 100, such as Colt Telecom and Energis, attracted huge City followings, as experts predicted massive demand for new networks to carry the explosion in data traffic.

Unfortunately for them, many others had the same idea. 'The excess of fibre they put in was phenomenal. It created a fibre glut. There was nowhere near enough revenue to justify it. It was as if 20 players each thought they would grab a 30 per cent market share,' said Andrew Heaney, a partner in Spectrum Consulting.

Despite these naive plans the banks and investment houses fell over themselves to lend money to telecoms companies. In Europe alone, the companies which caused misery to motorists and pedestrians alike by ripping up roads to lay cables, managed to borrow a staggering $600bn.

Timing was crucial. In the latter half of the Nineties everyone was desperate to lend. 'You had a period of declining interest rates and rapid growth in the [stock] market. People were looking for higher-risk investments that would offer high returns,' said Victor Basta, an executive at the investment firm, Broadview.

'Some companies were phenomenally successful. They borrowed their way to stardom and this started an emulation exercise.'

Even establishment firms noted for their prudence often allowed the roaring financial markets to push them into rash investment decisions. The likes of BT and Deutsche Telekom of Germany threw caution to the winds.

'If two years ago they had said they didn't want to get into all of this dotcom stuff, they would have been labelled Luddites. The management would have been shown the door,' said Mike Cansfield, principal consultant with the telecoms analysis firm Ovum. With their inflated sense of worth boosted by inflated share prices, the major firms went on wild spending sprees.

Deutsche Telekom bought the fourth largest British mobile phone company, One2One, while BT made disastrous investments in Germany and the Far East. France Télécom ended up with Orange, the UK's largest mobile phone network. All launched their own internet service providers and made ambitious claims about their ability to deliver high-speed, or broadband, internet services to consumers' homes. Suddenly companies like BT were seen as internet giants. 'Hype begat hype which begat hype,' said Cansfield.

It was the mobile phone sector that suffered the worst excesses. Three years ago City analysts forecast that there would be little more than 16 million users in the UK by the end of 2000. The actual figure was nearly 38 million.

As the City woke up to this phenomenal success, the mobile phone companies talked up their prospects even further by claiming that their forthcoming handsets with fast internet access would become a massive tool for selling. It would be m-commerce, their answer to e-commerce.

Share prices rocketed. As a result Vodafone was able to issue a jaw-dropping 52bn new shares to pay for takeovers in the US, as well as the £115bn purchase of the huge German firm Mannesmann in the largest hostile takeover in world business history.

But the exorbitant cost of bidding for government licences to run mobile internet services - through third-generation, or 3G, phones - has crippled the industry. Last year five firms, including BT, Vodafone and Orange, paid a total of £22.5bnat an auction.

The new services, however, have been hampered by delays and technology unable to handle high-speed data.

The only winners seem to be the highly paid analysts whose job it was to value the firms. Few wanted to puncture the bubble. At the end of 1999, fully 79 per cent of them were advising clients to buy telecoms shares, while 20 per cent said investors who had them should hold on. Only 1 per cent recommended selling. The hype 'was self-perpetuating. It created a bubble which had to burst at some point,' Heaney said.

As companies missed their earnings targets, the pretence had to stop. It became apparent that they had paid too much for their acquisitions. As the economic downturn hit home, the world's capital markets dried up. Firms found it hard to borrow or issue shares to pay for further investment.

Confidence in the industry has collapsed. Most firms' share prices have crashed by 70 per cent, and some by as much as 95 per cent. Trillions of pounds in paper value has simply disappeared.

Surveying the wreckage, Basta of Broadview said the companies made a crucial mistake by 'underestimating people's inertia. It was harder to get consumers to switch to new providers and to pay for new services than they thought'.

He estimates the average European telecoms firm has spent more than £5,000 for each customer won in the last two years, while the users have so far spent only around £1,200 a year. This is a gaping chasm few companies can straddle. For their beleaguered shareholders there is more bad news to come.

http://www.guardian.co.uk/Observer/focus/story/0,6903,548951,00.html

-- Martin Thompson (mthom1927@aol.com), September 09, 2001

Answers

How could it possibly get much worse?

-- Loner (loner@bigfoot.com), September 10, 2001.

Things can always get worse. Turnarounds after crashes generally happen only when the consensus view becomes "How can things possibly get better?"

IMO this recession will become a depression if the financial system itself collapses (not just the value of particular financial assets).

-- Barb Knox (barbara-knox@iname.com), September 10, 2001.