Lying, baiting & then whining is unacceptable behavior and I shall bury you financially for it:
businessweek.com
Telecom's Wake-Up Call
The industry could be headed for a downturn
Just about any place you look in the telecommunications industry these days, there
are signs of trouble. The stocks of the Big Three long-distance companies are all
down at least 40% for the year. The biggest local-phone companies--Verizon
Communications (VZ), BellSouth (BLS), and SBC Communications (SBC)--have
seen their shares slide. And there's a bloodbath among the dozens of
telecommunications upstarts that have been founded in the past few years. The
stocks of Viatel Inc. (VYTL), RSL Communications Ltd. (RSLC), and several
others have tumbled 75% or more since the beginning of the year. GST
Telecommunications Inc., a Vancouver, (Wash.)-based provider of phone
services in the Western U.S., had to auction off its assets in August after filing
for bankruptcy protection.
What's going on? For the past three years, the telecommunications industry has
been one of the economy's most promising sectors. In the wake of deregulation,
companies have been pouring billions of dollars into new communications gear to
deliver everything from telephone service over cable-TV networks to Internet
access over mobile phones. Capital spending soared from $42 billion in 1996 to
$82 billion in 1999. And it's likely to go higher: Analysts project telephone
companies will invest more than $100 billion in their networks this year.
''WAY OVERCAPITALIZED.'' But now the evidence is growing that all that
money isn't being well spent. While capital expenditures have soared 25.5%
annually since 1996, telecommunications revenues have increased a modest
10.5% per year, to an expected $326.6 billion in 2000, according to Lehman
Brothers Inc. The result is that for every dollar invested, telecommunications
players are seeing less and less revenue produced. In 1998, there was 42 cents in
new revenue for every $1 invested. This year, that's expected to fall to 34 cents,
according to Lehman Bros. That has put the squeeze on profits: Return on assets
for the industry has dropped steadily from 12.5% in 1996 to an expected 8.5% in
2000. ''It looks like the sector is way overcapitalized,'' says analyst Blake Bath of
Lehman, which issued the first detailed report on the situation in early September.
''Spending has grown at absurdly fast levels relative to the revenues and profits
produced by that spending,'' says Bath.
What telecom companies have been doing is betting on the future. With the boom
of wireless and data services, many experts thought growth in the $300
billion-plus industry would accelerate to about 15% per year. That would mean an
extra $50 billion or so in revenues each year for companies to divvy up. What if
that acceleration doesn't materialize? What if it remains at the 10% that the
sector has averaged in recent years? Certainly, there still will be winners in
telecom, but some players will reel. Returns on investments would be below
expectations, many stocks would continue to dip, and investors may even cut off
funding to some telecommunications companies by declining to buy their debt and
equity.
Eventually, if revenue growth keeps falling short of the high hopes, there are likely
to be repercussions throughout the economy. For starters, it could become
difficult for some of even the biggest telecom companies to keep digging into their
pockets for the billions of dollars they need for new investments each year. Any
significant drop-off in capital spending in 2001 or 2002 would first hit the makers
of communications gear, a white-hot segment of the stock market right now.
Nortel Networks (NT), Lucent Technologies (LU), Cisco Systems (CSCO), and
even highfliers like JDS Uniphase Corp. (JDSU) depend on the telephone
companies for their livelihood.
COMING UP SHORT. More broadly, any trouble in telecom could end up
crimping economic growth. In 1999, the telecom sector accounted for 16% of the
capital expenditures of the Standard & Poor's 500-stock index, far and away the
most for a single industry. Given that importance, any slowdown in capital
spending by the phone companies would make it more difficult to sustain the rapid
productivity gains that have powered the current expansion.
That's hardly a paranoid, worst-case scenario. Even today, the telecom industry's
performance is beginning to come up short. Company after company, from
AT&T (T) and WorldCom (WCOM) to Sprint (FON) and Verizon, have admitted
recently that they're not going to hit the financial targets they had anticipated.
AT&T, for example, told analysts its revenues would increase by about 6% from
last year's $63 billion, not the 8% to 9% rate it had previously expected. Even the
growth segments of the industry, while doing well, are not quite living up to
expectations. WorldCom Inc.'s Internet revenues increased 40% in the second
quarter, to $1.2 billion, instead of the 45% analysts had been expecting. And both
Verizon Communications and SBC Communications missed their initial targets for
rolling out broadband Net connections, which could temper revenue growth.
Still, telecommunications players have little choice but to continue making the big
capital bets for now. Because of severe price competition, revenues from the
traditional long-distance and local voice businesses are expected to be stagnant
over the next five years, at about $200 billion. At the same time, revenues from
Internet and data services are projected to rise an average of 24% per year, to
$150 billion in 2005, and wireless sales 20% per year, to $125 billion in 2005. In
other words, the major telecommunications players need to keep investing heavily
in these new services to have a shot at a high-growth future. ''When you look at
our capital spending, there's a clear correlation to our growth businesses: wireless
and data,'' says Frederic V. Salerno, vice-chairman and chief financial officer at
Verizon Communications, which is sinking $18 billion into capital expenditures this
year, compared with $13 billion last year.
The situation is going to get worse before it gets better. Bath anticipates that the
industry's capital spending will soar an astonishing 64% next year, to $173.3
billion, as companies bid on new wireless licenses being auctioned off by the
Federal Communications Commission. That will drive down the revenue produced
per dollar of capital investment 25%, to 26 cents, in 2001. And profits once again
will probably be crunched.
Clearly, the situation isn't sustainable over the long term. If investors continue to
see returns dropping in telecommunications, they're going to start moving their
money into other, more promising industries. There's evidence this already is
starting. The amount of money raised by telecommunications companies in debt
and equity offerings tumbled to $894.5 million in August, down from an average
of $7.6 billion per month in the rest of 2000, according to Thomson Financial
Securities Data. Junk bond issues, which have helped finance many of the
upstarts, shriveled to $324.6 million in August, compared with an average of $1.9
billion in the rest of 2000. ''Some of our diversified-portfolio managers are
throwing in the towel,'' says Brian Hayward, portfolio manager of the Invesco
Telecommunications Fund and strong advocate for the sector. ''They're trimming
their holdings [in telecommunications] because they think it's just not a good place
to be right now.''
SCRAMBLING. With capital becoming harder to come by, the
telecommunications industry is headed for a shakeout. Small players will likely be
the first to get hit. Many were founded on the assumption that they could lose
money for several years, but investors are showing less patience. GST
Telecommunications was the first of these upstarts to go out of business. Now,
other companies, including RSL Communications, ICG Communications (ICGX),
and e.spire Communications, are scrambling for new cash and may have to sell
out soon, analysts say. ''We think the tightening of access to capital will bring a
wave of consolidation,'' says Clark E. McLeod, CEO of McLeodUSA Inc., which
provides local and long-distance phone service, primarily in the Midwest. The
stronger upstarts, such as Nextlink Communications Inc. (NXLK) and Allegiance
Telecom Inc. (ALGX), are likely to acquire some of the weaker companies to get
broader phone networks on the cheap.
The major telecom players should be able to continue their spending spree through
next year. They're counting on using a favorite Wall Street trick: issuing tracking
stock for one coveted piece of their businesses. For example, AT&T had an initial
public offering for its wireless operation earlier this year and pulled in more than
$10 billion. Verizon filed for an IPO for its wireless business and may raise as
much as $15 billion. SBC is expected to follow suit later this year with an offering
of the wireless operation jointly owned by it and BellSouth. That deal could raise
an additional $15 billion. All told, the major telecommunications players are
expected to reap an additional $60 billion or so through the end of 2001 by selling
off stakes in wireless and Net operations. If the companies can convince
investors to fork over that kind of dough, competition for customers will only
intensify over the next year or so. ''That's just going to throw fuel on the fire,''
says Bath.
Even the telecommunications industry's biggest names are going to have difficulty
not getting singed in the years ahead. If industry growth continues to be modest
with all that capital being poured into new networks, one or more of the largest
telecommunications players will end up in big trouble. There simply won't be
enough profits to go around. The losers will see net income shrivel and their stock
prices slide--and they'll have to cut expenses. ''Not everybody is going to be a
winner,'' says analyst Brian Adamik of market researcher Yankee Group.
Which companies are most vulnerable? Those that depend on the rapidly
deteriorating long-distance business. The list starts with AT&T, but it also
includes Sprint, WorldCom, and smaller players like Global Crossing (GBLX). The
central problem is that prices are tumbling--down about 10% since 1997,
according to Yankee Group. That contributed to an 8% decline in AT&T's
consumer business revenues in the first half of this year, to $10 billion. And that
price pressure isn't going to stop anytime soon. Lehman estimates that the
long-distance market is going to shrink more than 4% annually, from $78 billion
last year to $63 billion in 2004. ''Their core businesses are deteriorating a lot
faster than we expected,'' says Hayward.
Look for these companies to try to combine with others to gain economies of
scale and shore up profits. AT&T already has discussed merging with British
Telecommunications PLC (BTY). WorldCom and Sprint announced plans to
merge last year, but the deal was blocked by regulators. Now, the two companies
could end up being acquired by foreign telecom players or one of the Bells after
the local companies are allowed to offer long distance in more of their states.
''The one thing that can save an industry like this is consolidation, so that less
money is invested,'' says Jeffrey Heil, director of equity investments at the
Regents of the University of California.
By contrast, the giant local phone companies--SBC, Verizon, and BellSouth--look
well positioned. Their local networks are costly and complicated to replicate, so
they're facing relatively little competition. The local-phone giants ''own the last
mile, and that's an asset that won't be duplicated,'' says Invesco's Hayward. At
the same time, they're demonstrating that they're capable of taking market share
away from the long-distance companies. Verizon, for example, has swiped more
than 1 million long-distance customers in New York, and SBC has grabbed more
than 500,000 customers in Texas in just two months. What's more, all three of
them generate loads of cash that will help them finance expansion into new,
fast-growth services. Verizon, for example, is expected to have cash flow of $28
billion this year, more than either AT&T or WorldCom, according to analysts'
estimates.
TURNING THE BATTLESHIP. Not that Bell companies are immune to
competition. AT&T is rolling out local telephone service over the cable-television
networks that it has acquired. It expects to pick up as many as 650,000
cable-telephony customers by the end of this year--not just for the additional
revenues but also to cut into the cash flow of the local phone companies. And the
upstarts that still have financing are aggressively pursuing lucrative business
customers. ''The incumbents are going to have the hardest time reacting,'' says
Royce Holland, CEO of Allegiance Telecom, which provides local, long distance,
and data services to corporations. ''You can't turn that battleship quickly.''
For the telecom industry, the freewheeling days are ending. ''Companies made a
lot of promises, and now it's time to pay the piper,'' says Robert C. Taylor Jr.,
CEO of Focal Communications Corp. (FCOM), which provides local and
long-distance services to corporations. The cost for the telecom sector--and the
rest of the economy--could be high.
By Peter Elstrom, with Michael J. Mandel, in New York |
