DJ IN THE MONEY: Cash Concerns Mount At Global Crossing 22 Jun 13:06
By Steven D. Jones A Dow Jones Newswires Column
PORTLAND, Ore. (Dow Jones)--Shares of Global Crossing Ltd. (GX) have plunged
31% this month on the fear that deep discounting in the long-haul telecom
business may mean Global won't be able to generate enough cash to complete its
worldwide network.
Deal making is secretive in every industry, especially in telecom where
competition is rabid. But evidence is appearing that the traditional practice
of selling capacity under lucrative 25-year contracts is starting to change in
ways that may diminish the cash flow for telecom upstarts already struggling
with high debt and decreased demand.
Global Crossing generated about half of its revenue last year selling
capacity to phone companies such as Deutsche Telekom AG (DT) and WorldCom Inc.
(WCOM).
Global Crossing is developing high margin services for specific markets. Its
entertainment industry offerings, for example, would allow a producer in
Hollywood to view takes shot in places as far away as Thailand. Global Crossing
is developing similar services for other industries.
The company claims the strategy will give it positive cash flow in the second
half of this year. Add to that $2 billion from asset sales and Global Crossing
says it will generate enough cash to cover the more than $4 billion it will
take to complete the Asian leg of its network early next year. Global Crossing
already operates a fiber-optic network that connects 200 major cities in 27
countries in Asia, the Americas and Europe.
But the industry's massive debt and the woes of competitors such as Level 3
Communications Inc. (LVLT) and 360Networks Inc. (TSIX) has pulled down the
prospects of every player in the business, and it may be pulling down the
pricing power in the industry as well.
With a glut of fiber-optic lines, cash-strapped competitors are beginning to
sell cheap to survive. And companies are beginning to lease capacity - with
some leases as short as three to five years - instead of the 25-year, cash
contracts known in the industry as IRUs.
Concerns Of Funding Gap
Rumors of the change hit Global Crossing last week when Credit Suisse First
Boston analyst Daniel Reingold estimated Global Crossing might fall $550
million short of the cash it needs to complete its network by next spring. The
reason says Reingold: "the trend away from upfront IRUs towards short term
leases."
"The minute you say 'funding gap' in telecom everybody runs for the hills,"
says Donna Jaegers, an assistant portfolio manager for Invesco Funds Group Inc.
in Denver. Evidence of the change is scant, she says, but the concern is real.
In a press release Thursday, Tom Casey, Global Crossing's chief executive,
announced the South American leg of the network was complete. He reiterated
that his company's business plan was fully funded and the Asian segment of the
network will be completed in the first quarter of 2002 as planned.
IRU stands for "indefeasible right of use," a concept that has grown out of
real estate law. The purchaser of an IRU has the right to use a communications
circuit for a specific time and the right to a certain amount of bandwidth. An
IRU is to a fiber cable what a condominium title is to a building; it is a
legal right that the owner pays for in cash up front.
All of the new-age telecom companies laid large amounts of fiber-optic cable
and sold chunks of the capacity through 25-year IRUs to fund expansion.
To buy capacity valued at $1 million a year, a company would pay $25 million
in cash. The telecom company booked $1 million as revenue in the first year and
put the balance in deferred revenue to be drawn into its cash flow for the next
24 years.
IRUs were the ideal growth vehicle for the telecoms because bankers take
deferred revenue into consideration when calculating debt covenants, which
enabled the companies to continue borrowing as they sold capacity.
Global Crossing in the first quarter listed $2.43 billion in deferred revenue
on its balance sheet even though it only listed $1 billion in first-quarter
revenue on its income statement. But in its consolidated financial statement,
Global Crossing's first-quarter cash revenue was $1.61 billion thanks to the
$513 million it pulled out of deferred revenue.
The IRU is such an integral part of the long-haul telecom business that the
threat it may erode in a flood of wheeling and dealing among struggling
competitors has led to apprehension. Change May Be Inevitable
Reingold of Credit Suisse wasn't available for comment, but provided his
research that says the whole sector may soon feel the effect. He has lowered
his estimate of Global Crossing's cash earnings this year before interest,
taxes and depreciation to $1.9 billion, down 6% from his prior estimate. And he
has lowered his estimate of 2002 cash earnings to $2.1 billion, down 26% from
his prior estimate. He calculates that as much as 25% of Global Crossing's IRU
sales could shift to short-term leases.
The change is inevitable in a market with an oversupply of capacity and
falling demand, says a hedge fund manager who has sold short shares in many of
the new-age telecom companies, including Global Crossing. (Shorts borrow and
sell shares and profit if the company's stock goes down.)
He says proof of the trend appeared Tuesday when Excite@Home Corp. (ATHM)
announced it had renegotiated its IRU with AT&T Corp. (T) that refunds $85
million to Excite immediately in exchange for a new 18.5 year agreement that
will cost Excite $8.8 million annually.
Global Crossing's own announcement Wednesday that it will link the Los
Angeles studios of DirectTV, owned by Hughes Electronics Corp. (GMH), with the
Hughes satellite broadcast center in Colorado was also a short-term lease.
Donna Reeves, president of Global Crossing's Media & Entertainment Division,
says three- to five-year leases, not IRUs, will be "typical" in her division.
The contract terms were designed to appeal to an industry that "may become one
of the largest forecasted vertical markets for bandwidth," in the future, she
says. Shorter contracts are the norm, not the exception in the entertainment
industry, she says, and a logical change for Global Crossing to make to capture
what she says will be a "margin rich" business.
And even though executives of Global Crossing and some of its telecom clients
have discussed changing IRUs in favor of short-term leases, "we haven't seen it
yet," says Dan Cohrs, chief financial officer of Global Crossing. "There has
been some talk about this, but I don't think we have signed any significant
contract in the past year for lease service over IRU."
Cohrs said Global Crossing has found that buyers of large amounts of
communication capacity want the long-term rights that an IRU provides. It's
foolish to build a network you expect to use for 20 years around a
communication service that is only leased for three years. And if shorter
leases do emerge as a new contract strategy, Cohrs says Global Crossing can
manage the change.
"It's a higher present value and we could easily finance against the
receivables that would be created by the operating leases," he says. "To tell
you the truth, if we could do operating leases, I would do it."
-By Steve Jones, Dow Jones Newswires; 360-253-5400
(END) DOW JONES NEWS 06-22-01 01:06 PM |
