Tick tock goes the debt clock on three telecom stocks 2001-08-03
Examine a trio with high debt-to-equity ratios, projected per-share losses and recent analyst downgrades.
by Dave Sterman, equity research columnist
When telecom companies were growing quickly, they borrowed heavily in a race to outspend their competitors. But these days, they are retrenching at an equally hasty clip. Many companies are selling assets, laying off workers, and tightening their belts, all in a bid to stave off creditors.
As a result, Wall Street analysts are taking the fiscal pulse of the companies they cover. Instead of focusing on how fast profits can grow, the key question is now whether remaining cash levels will be sufficient to ensure survival. In recent days, firms such as ADC Telecom (ADCT) and Lucent Technologies (LU) have announced plans to cut costs and raise more cash.
Whether beleaguered telecom companies can survive is a key consideration for equity investors: if you already own the stock, then the situation bears close scrutiny. And if you're looking for short candidates to hedge your portfolio, these companies may fit the bill.
Using our proprietary NetScreen stock-screening tool we went looking for companies with high debt-to-equity ratios and those projected to continue showing losses. We found stocks that carry a debt-to-equity ratio in excess of 1.50 and that are expected to continue losing money at least through 2002. Lastly, we looked for stocks that have been the subject of downward revenue estimate revisions. If revenue projections are slipping, these firms will be harder pressed to eventually generate positive cash flow.
Exodus Communications (EXDS)
Shrinking cash reserves can lead to fears of eventual bankruptcy, making it difficult to attract new customers. Merrill Lynch's Thomas Watts cites Exodus as an example. He thinks the company "could slip into a dangerous spiral."
In his July 27 institutional report, he notes that the company must win customers to raise additional financing, but "faces difficulty winning new customers and retaining existing customers based on its financial distress."
Revenue concerns have already come to the fore. As the accompanying table shows See Below seven analysts have lowered their revenue estimates for Exodus for the fiscal year that ends March 2002.
Analysts currently assume that Exodus will burn through existing cash balances in the next six to nine months, unless new funding is secured. Exodus is a Web-hosting firm, and many of its customers are struggling dot-coms that are bankruptcy candidates themselves.
Akamai Technologies (AKAM)
The financial minefield of Akamai could prove instructive. Akamai's server technology helps distribute Web site content across telecom networks and the World Wide Web. In recent months, the company's stock has traded in the $7-10 range, even as its business outlook has deteriorated.
Although the company bagged $43 million in sales in the June quarter, analysts are taking down their outlook of future sales. In the next two quarters, they figure Akamai will garner sales in just the $36-37 million range. That shortfall will likely force the company to continue to hemorrhage cash at a rapid rate. Last June, Akamai had $516 million in cash. A year later, the company has just $267 million left.
On the quarterly conference call, management was quick to note that the current cash balance was quite sufficient to reach positive cash flow status. That forecast is predicated on 27 percent revenue growth in 2002. In a July 19 institutional report, Wit Soundview's Ian Brown disagrees.
"We believe it will be difficult for the company to ramp up revenues sufficiently to be able to (reach EBITDA breakeven)." Brown, who rates the stock a "hold," sees cash dwindling to just $51 million by the end of next year.
But many analysts offer up a less critical take. U.S. Bancorp Piper Jaffray's, for example, simply follows company guidance that revenue and cash burn estimates will hold steady in the quarters to come, and not deteriorate. In his July 19 retail report, he predicts that the company will still have $95 million in cash left by the time it becomes cash flow positive in 2003.
To be sure, Akamai added 120 new customers last quarter. But they lost 260 existing customers. As long as dot-com customers continue to bail, those financial forecasts should be viewed with a gimlet eye.
Level 3 Communications (LVLT)
With swelling debt loads, some companies are resorting to aggressive measures. With $9.7 billion in debt, Level 3 is struggling just to meet interest payments. In a July 27 institutional report, CIBC World Market's Timothy Horan estimates that Level 3 is paying out 40 percent of its revenue to its lenders. Most other companies would be hard pressed to pay out 40 percent of cash flow.
To escape some its debt burden, Level 3 is pondering a peculiar option: the company may offer bondholders to exchange their stakes for equity. To make that happen, Level 3 would have to make a very sweet offer to those creditors. Horan figures bondholders could "simply 'wait it out,' collect their contractually guaranteed coupon payments until LVLT burns through more of its cash and becomes tenable (sic) to their demands." Of course, a sweet deal for creditors would be a bum deal for existing shareholders, as their stakes would be diluted.
And any deal wouldn't necessarily keep the wolves at bay. Banc of America's Andrew Hamerling points out in a July 27 institutional report that Level 3 would likely retire about $1 billion in debt in such a transaction. That means the company would still be on the hook for another $5 billion-plus in long-term debt. Considering that Level 3's sales actually shrank 13 percent sequentially in the June quarter, debt service may yet prove too much to bear for this struggling telecom wholesaler.
Name D/E ratio (1) Downward revs. (2) Avg. EPS (3)
Exodus Communications (EXDS) 1.60 7 $ (0.68)
Akamai Technologies (AKAM) 2.57 8 $ (1.28)
Level 3 Communications (LVLT) 2.35 4 $ (7.33)
At Home (ATHM) 6.90 3 $ (0.29)
United Pan-Europe Commun. (UPCOY) 8.70 2 $ (3.69)
Williams Communications (WCG) 2.26 3 $ (2.15)
1. Long-term debt-to-equity ratio as of the most recent quarter
2. Number of analysts in the last four weeks who have reduced revenue estimates for the next fiscal year
3. Average forecast earnings-per-share for the next fiscal year |
