Barrons more pressure on MOnday.?
Stunted Growth
A team of tech-telecom specialists sees more static ahead for
investors
An Interview With Scott Cleland and William Whyman ~ As principals
of the Precursor Group, an independent research boutique in Washington,
Cleland and Whyman supply institutions with investment intelligence on
telecommunications and technology, based on a thorough reconnaissance of
the field and supplemented by their strong industry and government
connections. The two have distinguished themselves through an ability to alert
clients early to trends of consequence. Not only are they plugged in, they are
impartial. That's the critical difference separating them from the rest of the
pack. And it's a quality that allows them to focus on producing penetrating
analysis for the hedge funds and top money managers who pay up for the
privilege. For their current outlook on the state of telecommunications, read
on.
-- Sandra Ward
Barron's: You seem to have changed your views on the telecom sector.
Cleland: We are concerned that "Enronitis" has hit the whole sector and no
one is safe from the debt-spiral dynamic going on in telecom. It's a very
negative overall dynamic.
Q: Is your concern about access to the capital markets, or something
more?
Cleland: It's a lot more than that. There are severe fundamental negative
trends occurring in telecom. First, there is too much debt. It will have to be
worked off. There is huge overcapacity in the system and no one can afford
to take on more debt in order to cull the overcapacity.
Q: This was true a year ago. What's changed?
Cleland: What has changed is that no telecom company right now is strong
enough to be the cavalry to rescue everybody else. We thought the Bells were
going to remain strong players that could come in and take out the
overcapacity and that would be the rallying point that allowed the sector to
stabilize. After Enron, even the biggest companies, the aircraft carriers like
SBC Communications, Verizon and BellSouth, the three that could still raise
capital if they wanted to, have no desire to take on additional debt or
additional business risk. Most people thought consolidation was a dynamic
that could stabilize this sector, and now it's every company for itself. We have
a situation where no one is willing to pluck somebody out of the water and put
him into their lifeboat.
Q: Isn't there a price for everything,
especially a strategic move that could
help future business?
Cleland: What we've seen over the last
year is that even at pennies on the dollar
people didn't want the CLECs. The
reason they didn't want the CLECs is
that they didn't want to take on new
liabilities. What is happening here is a
very negative dynamic. The companies
that have too much debt are going to
have to restructure. The existing
bondholders are going to be the losers.
Coming out of a restructuring, the
companies will then need to take share.
The only way they can take share is by
lowering prices. That creates
competition on steroids. What concerns
us is that this could be a dynamic where overcapacity continues to exist. It
could be like the steel industry, where companies go into bankruptcy,
restructure, come back and lower prices, and still find themselves not making
it. The overcapacity in the transport area is spectacular.
Whyman: It is not just a question of debt. It is deeper. The economics of
bandwidth will, as Scott said, start to look like a commodity product. You
have excess capacity, high fixed costs and falling prices. The analogy to the
steel industry is a good one. You look at the economics of it, you look at
charts and you say to yourself, "I've seen this chart before and I don't like it."
Q: Except the steel industry seems to have had a longer run than some of
these companies.
Whyman: Technology changes a lot quicker. I also would argue that the steel
industry had a lot of government support in terms of tariffs, which basically
end up driving prices up. In the telecom industry you've had the FCC and the
Telecom Act driving prices down.
Cleland: The monsterish trend in telecom right now is hugely negative for
margins. The industry is shifting from high-margin voice minutes to very low-
or no-margin data minutes. There's the huge trend of wireless substitution
where people are moving in large numbers from profitable wireline minutes to
much lower margin wireless minutes.
Q: Prices continue to drop there, too.
Cleland: Prices don't drop in wireless; more minutes are given away. They're
totally commoditizing wireless and it is having a negative effect on wireline as
well. Government policy has made this competition dynamic a disaster. The
government sucked capital out of telecom in a big way and created enormous
disincentives for investment. Then there's the debt spiral we're in now. We're
left with less profitable migration to voice, less profitable migration to wireless,
a hyper-competitive deflationary government policy of competition and
overwhelming debt. Put the four together and the economy can't pull this
sector out of its hole.
Q: What can? What has to change?
Cleland: That's what really concerns us. This is a dynamic that will last
awhile. This sector is not going to bounce back quickly. We tell people
telecom-tech is no longer the economic propeller of the economy. It may be a
drag.
Whyman: From 1997 through the third quarter of 2000, investment in
equipment and software was adding roughly a point to the gross domestic
product growth every year. It was responsible for roughly a quarter of all the
growth. Starting in the fourth quarter of 2000 all the way through 2001, it has
actually been a drag on economic growth. It has gone from roughly adding a
point of GDP growth to knocking nearly a point off GDP growth. That's a big
deal.
Q: You speak generally of telecom, but which sector is this most acute
for?
Cleland: This dynamic is worst of all for the equipment segment and
especially the data optical segment. This segment was the biggest part of the
bubble during the late 'Nineties. Those stocks literally levitated the Nasdaq by
mind-boggling proportions. What we have right now is what we call "beta
parking," where investors have parked in high-beta stocks that were high
growth in the past, hoping they will roar back.
Q: Companies such as Cisco and ...
Cleland: Cisco and JDS Uniphase and Ciena and Juniper, and Sycamore
Networks. Demand overall is getting crushed. |
