A Fund Manager Looks for Survivors
The Washington Post
Wednesday, February 28, 2001; 10:17 AM
Robert N. Gensler has been portfolio manager of the $797 million T. Rowe Price Media and Telecommunications Fund for seven years. Gensler’s fund achieved a 20.98 percent annualized return over the past three years, which puts him in the 20th percentile of comparable funds. Gensler is cautious about the telecommunications sector and says that despite the already hefty drops in the stock prices of many of the companies, it’s too soon to say the worst is over. What follows are edited excerpts from a conversation with The Post’s investing columnist, Fred Barbash. Q: Are we going through a significant shakeout in the telecommunications industry?
A: Absolutely. If you look back prior to 1996 and the Telecom Act, you basically had a telecom industry made up of one or two competitors in every product-set silo. You had one cable provider, one local provider, two wireless providers and really three long-distance providers in the U.S.
Because of deregulation, [the Internet] and a new kind of capital market that would fund people who lose money, you went from one or two providers in each silo to five or six providers. It was a classic deconsolidation of an industry. The fundamental shift that’s going on, which started last year but we didn’t know it at the time, is the reconsolidation of the industry. Give us an analogy.
I liken it to the airline industry years ago. In the airline industry, after all that deregulation and all the craziness in the [launching of new airlines] and all the rest, you really still have the incumbents there, consolidated down to a few players. And we have the customers who think the services still stink. In telecom, we could be headed back to that, hopefully not.
How much reconsolidation do you see ahead?
I predict that within three to four to five years there may only be four or five large telecom providers in the United States and in every other country, similar, if not fewer.
Between 1996 and 1999 we were just creating new companies, “we” being Wall Street. Anybody who came with a good business plan, good PowerPoint slides and used to work at MCI, AT&T or WorldCom could get funded. So we funded a lot of very smart people with new technologies. Technology enabled people to come in and take someone else’s network, come in and attach to it and sell service. It was the whole thing between the hunter and the hunted. And you had a huge new hunting class going after the incumbents. Fortunately for the industry, you had incumbents, like AT&T, who in their genetic coding since 1984 seem to want to cede market share.
We funded all these new companies. But we didn’t fund them for profitability. We funded them thinking about revenue growth. And that has fundamentally changed.
What are the ramifications for the broader technology sector?
All of technology investing today is really communications-related. It’s really communications and the Internet. It’s data. It’s wireless. Those are the drivers to technology investing. In software, it hasn’t been Microsoft, which is PC-related. It’s been communications-related software, whether it is Oracle, Veritas or Siebel. In communications equipment, it’s Cisco, Nortel, Lucent and the rest.
Of the investable market cap in tech [i.e., the total dollar amount of freely traded stock], communications equipment is over 34 percent of tech directly. The two-thirds that is not communications equipment, over half of that is communications related. This doesn’t sound good.
In communications-related tech, the ramifications of the services “space” [or sector] reconsolidating are not good. Prior to 1996, communications-services spending on capital equipment, broadly defined, was growing maybe 8 percent a year. All of a sudden deregulation and technology come along to the point where spending growth was 35 percent.
Communication-services revenue growth did accelerate from about 8 percent five years ago to about 10-12 percent today. But the spending on capital goods was up 35 percent in 2000; 25 percent in ’99; 20 in ’98; 16-18 percent in ’97. You can’t do that forever. Returns on capital for the services guys have gone down systemically for five years, and badly down.
And the investing community was paying for it?
Wall Street was giving them the money for free so everybody spent. Now, all of a sudden, the [chief financial officers] are allowed to raise their hands and say no [to more capital spending]. And that’s what happened last fall. That’s why this year is fundamentally different.
Level 3, Williams, Qwest, Nextlink, etc., etc.—the new entrants [in the communications network field] got cut off from their lifeblood last March, mainly in the high-yield [debt] markets. Nothing says the demand drivers aren’t still there. The problem is we’ve got too many companies trying to give you the stuff. We have this unstable situation where companies have too low of a market share.
What do you mean by “unstable”?
It could be very destabilizing. Level 3 is the extreme case. They want to buy the latest fiber from Corning and light it up with the best gear from Nortel and Ciena. They say, “I can have better economics from here to L.A. than anybody else.” But the funny thing about telecom is if you have a $10 billion network as Level 3 will, and you only have one customer, your economics stink.
It’s back to airlines, which is a scary analogy. If I have a 747 with one person on it, my economics stink. I need to load the airplane. Level 3 needs to load its pipes, its bandwidth. So it’s got every incentive to be destabilizing in price because that’s the only way you steal market share.
So this could be great for customers but lousy for investors?
Yes. I think it’s going to be great for the American economy in the long run. It was a misallocation in a way. But look what we got for it.
But many people still can’t get high-speed, broadband access to the Internet in our homes and offices. I don’t get it.
The [problem is with] the on and off ramps of the highway. Arguably, we’ve not overspent there. There’s still congestion. So I’d love to invest in those on and off ramps. But it gets back to the people who own the on and off ramps. It’s owned by the Bells and it’s hard to replicate.
And this makes it difficult for the smaller players and contributes to reconsolidation?
The DSL [high-speed, digital subscriber line] vendors—Covad, Rhythms, North Point—one out of three is bankrupt and all three [are in trouble] Williams Communications could go belly up eventually, and I think 360 Networks. Also all CLECS [competitive local exchange carriers] other than the top four or five. If it’s not bankruptcy it’ll be mergers. Worldcom won’t be an independent company. Sprint won’t be independent. AT&T Wireless may not be independent. Nextel won’t be independent.
Who survives?
If you look out two years, you could see a scenario where SBC buys Worldcom; Qwest buys BellSouth and Sprint. When Qwest buys BellSouth and Sprint, Cingular, which is the wireless joint venture between them, goes to SBC. So now all of a sudden you’ve got Verizon, SBC and Qwest being the three players. Three mega-players looking a lot like the old AT&T.
Let’s get back to the impact on the telecommunications value chain on technology.
We’ve cut the stock [prices] in half, right? We should have all figured it out earlier but some of us didn’t. Some of us did. The real dilemma in the stock market today is how much is already known of what I’m saying. Is it already [factored into the price of] the stocks or is it not? I would argue that it’s not fully.
So let’s talk about investors.
Back to the food chain. What happens is, we all think that [for the stocks that trade on the Nasdaq Stock Market] the problem is only the March quarter and maybe the June quarter. Then we get back to really good growth. What investors are missing is, it’s probably more than just the June quarter and we probably do get back to growth. But the growth will be lower. I’m not sure people have fully digested that. And the really dirty little secret that no one on Wall Street talks about is, when you have slowing growth, from hyper growth to good growth, what happens to [profit] margins? If all we have is slowing revenue growth, maybe we’re okay. If we actually have any [profit] margin issues, I don’t know. Then we’ve got more legs down in this Nasdaq.
So what does a good fund manager do?
Hide. What I’ve done is I feel that the services space has to heal itself before the technology space can. So I’m overweight services and underweight technology. And I’m very overweight wireless services and particularly overweight in overseas wireless services.
If you had to make the bullish argument, what would it be?
That [the bad news is already reflected in the price of] the stocks. Fundamental demand is very robust so that will save the day.
My point is, yeah, maybe, but I don’t agree. In semiconductors, it’s so cyclical that we anticipate the cycles and trade ahead of them. In communications equipment, we’ve never seen a cycle before. Nobody knows what one looks like. So we’re already anticipating the upturn in the cycle? We’re just getting to the top of the mountain. We’re just staring over the top of the mountain. We don’t know where the bottom is. |
