Ravi Suria (continued)
Ravi Suria: One, over the past five years, cash flow in the telecom services
sector has been growing between 8% and 12%. But the money they have
been spending on plant and equipment has been growing at about 40% a
year. This is clear example of the recent investment-driven economy, that
capex spending was dependent on the telecom services companies borrowing
money. This is a great example of what I call overstimulation of demand
through easy availability of credit. In the long run, investment demand is tied
to how much money companies actually make. What this implies for the next
three to five years is that telecom spending growth rates will be down to the
actual cash flow growth, which is 8% to 12% a year. This is the best-case
scenario -- assuming the cash flow is not used to start repaying debt -- which
is an heroic assumption.
Brett D. Fromson: Does the level of telecom service capex spending have to
drop before it starts growing at all? Does the absolute level of capex spending
increase from current levels, or does it have to go down substantially before it
begins increasing?
Ravi Suria: I expect aggregate capex will have to go down to 1998 levels, at
least, before it resumes growing again.
Brett D. Fromson: Why?
Ravi Suria: Because a substantial amount of what was spent in 1999 and
2000 was money that companies did not have and had to borrow. A lot of the
money borrowed by the big guys over the past few years is coming due in
2001. For example, European telcos alone have to raise about $190 billion
this year to refinance existing debt. That is not to repay or bring down debt.
That is a lot of money.
So, the first $190 billion raised through bank loans, bond market offerings and
wireless IPOs will be used to refinance existing debt. If they manage to
borrow that much money, then they may start spending on capex. Maybe. In
the U.S., for example, AT&T has $25 billion of commercial paper coming due
this year. None of these financial pressures existed over the last several
years. The debt that you borrowed you could spend on equipment.
Brett D. Fromson: So how do those financial pressures hit the equipment
makers?
Ravi Suria: Look at Nortel (NT:NYSE - news). The company's revenues went
from about $17 billion in 1998 to $30 billion in 2000, some because of
acquisitions. Ask yourself who were all the new buyers of Nortel equipment? I
would say they were people who had borrowed in the capital markets. I would
say that Nortel's revenues may have to decline to the $20 billion level before
they actually become sustainable, and that could take a couple of years.
Brett D. Fromson: What about Lucent and Cisco?
Ravi Suria: Lucent's revenue estimates for 2001 have come down all the way
from $45 billion to $25 billion. That is a contraction. The telecom equipment
companies that will show the biggest contractions are those with the largest
revenues, because they are the ones that captured the most dollar amount of
revenues from money that was borrowed over the last couple of years. You
could see the revenue bases of companies like Nortel and Lucent actually
come down by 30% to 40% before the revenues stabilize. Cisco is getting to
that revenue level, too. Just to show flat revenue growth, Cisco must replace
more than $20 billion in revenues.
On the other hand, Ciena (CIEN:Nasdaq - news), with $1 billion in revenues,
needs to find only $1.5 billion in revenues to show 50% revenue growth. The
point is that once you get big, it becomes harder to show growth, especially if
you're in a capital goods industry like these companies. You have to convince
the person who bought 10 routers this year to buy 10 more next year and then
another guy to buy another five routers to show 50% growth. The larger the
company, the more I expect to see a contraction in revenues.
Brett D. Fromson: Obviously, you do not see a return to the growth rates of
1998-2000 to return anytime soon.
Ravi Suria: I do not. The extra lump of demand for this equipment just does
not exist from sustainable cash flows. It just doesn't exist.
Brett D. Fromson: After the revenue contraction, when would you expect
revenue levels to return to 1999-2000 levels?
Ravi Suria: That's hard to say. For companies to spend money on telecom
equipment, they have to get it from somewhere -- internal cash flow or the
capital markets. In the last few years, it has come from the markets. On the
telecom services side, people are beginning to understand that these are no
longer growth companies -- they are highly leveraged companies. On the
telecom equipment side, the market will realize that they never were secular
growth companies. They are capital equipment companies; they're cyclical
just like the semiconductor equipment companies. You don't find
semiconductor equipment companies giving vendor financing for customers to
buy their equipment because they know there's always a downside to a cycle.
This is something the telecom equipment manufacturers forgot.
"It's ironic that the unprofitable tech IPO cycle started with Netscape, the
first Marc Andreeson IPO, and probably ended with his next IPO,
Loudcloud."
Brett D. Fromson: How then do you think these telecom equipment stocks
should trade?
Ravi Suria: As capital goods stocks. That's what they are. They are not
growth companies. The smaller ones can show good growth for a few years,
but once they hit a critical mass of revenues, they are cyclicals.
Brett D. Fromson: That means lower P/Es, of course.
Ravi Suria: Yes. Absolutely.
Brett D. Fromson: Telecom services and equipment have been two of the
fastest-growing sectors of the economy in recent years. What does it mean to
the overall economy that they are contracting?
Ravi Suria: This economic cycle has been driven by investment spending. If
you look at GDP (definition | chart | source) growth, investment growth has
been greater than consumer spending growth. Government spending has been
going down. And we have been running a trade deficit. So most of the demand
has been spurred by investment spending. Now, you slow that down. What
you could see in the next few years is a sharp falloff in investment spending.
It's hard to say that companies won't be spending more on technology. But I
think we went through a substantial upgrade cycle over the past five years,
and unfortunately cash flow growth, which at the end of the day actually gives
you the ability to spend more, has not substantially improved for corporate
America. I do not know how much of a crimp it will put on economic growth,
but I would say that if you think that investment spending is going to fall off a
cliff, you could make an argument for lower GDP growth more closely linked
to the growth in consumer spending. And that would not be a four-quarter
phenomenon. It would be a phenomenon until debt leverage across the board
starts coming down.
Brett D. Fromson: What is your outlook for IPOs?
Ravi Suria: I think we're going into a severe down cycle for IPOs.
It's very simple. Go back and look at history. Before 1995, most companies
that came public had four to six years of operating history and a year of
profitability. What we had in the past several years were companies that had
been around for less than two years going public. So when they came public
they were still in that very fast part of the growth curve.
The public mistakenly thought that was the rate at which these companies
would be growing forever. They did not understand that all new companies
grow that fast. It was just that before 1995 the public didn't see these
companies because they were still privately owned. Here is the key part. A lot
of the private companies that would normally have done an IPO between
2001-04 would have been founded between 1996 and 1999. Unfortunately,
most of the companies founded between 1996 and 1999 have already been
taken public. So, the next crop of IPOs that will come through will be
companies founded in 1999-2001. So, over the next few years, there will be a
much smaller number of new company IPOs. The replacement will be big
IPOs like Agere from Lucent and Kraft Foods from Philip Morris (MO:NYSE
- news). And you'll see more seasoned companies like energy companies
that have been around for 20 or 30 years come public. The boom for tech
IPOs is gone. You took about 10 years' worth of IPOs and compressed them
into four. I think it's ironic that the unprofitable tech IPO cycle started with
Netscape, the first Marc Andreeson IPO, and probably ended with his next
IPO, Loudcloud (LDCL:Nasdaq - news).
Brett D. Fromson: Let's change gears and talk briefly about a company that
you know well, Amazon.com.
Ravi Suria: Amazon is a retailer that was masquerading as a tech company
for a number of years. It borrowed too much money. And the money is running
out. Unless somebody comes and gives it more, the company will have to go
through restructuring in the next 12 months. That doesn't mean it goes out of
business. The Web site survives. It's a great asset and it will be a great asset
to somebody. It just means that the current capital structure and the current
operating model don't work. Their operating model clearly does not work. Why
not? Because it doesn't make money. As somebody said the other day,
"Anybody who sold one paper bag for a 10-cent profit made more money, a
heck of a lot more money, than Amazon has over the past five years."
Debtholders will most likely end up owning the company.
END.
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