Telecom Industry Leaders Struggle With Growing Debt, Overcapacity
By REBECCA BLUMENSTEIN and GREGORY ZUCKERMAN
Staff Reporters of THE WALL STREET JOURNAL
A perfect storm has hit the telecom business, spreading beyond small upstarts to threaten some of the industry's biggest players.
A few months ago, most of the damage seemed confined to overleveraged newcomers competing with Baby Bells and to fiber-optic companies brought low by a spectacular glut of cable.
But now, spooked by accounting questions and faltering growth prospects, investors and banks are recoiling from the whole $300-billion-a-year industry. Long-distance carriers, wireless companies and even local phone giants are getting caught up in the turmoil, and many face sharply higher borrowing costs at a time when they most need access to capital.
"It's never been this bad, not even close," says Scott Cleland, chief executive of Precursor Group, an independent research company based in Washington, D.C.
Signs of distress are everywhere:
• On Monday, WorldCom Inc. and Qwest Communications International Inc., two of the nation's largest phone companies, acknowledged that the Securities and Exchange Commission is investigating their accounting practices. Two congressional committees have joined the SEC in looking into Global Crossing Ltd.'s bookkeeping. All say their accounting is proper, but the news added to fears that accounting issues could cast a shadow over the industry.
• Last month, Sprint Corp., found itself unable to raise as much short-term cash as it needed in the relatively inexpensive commercial-paper market. The nation's No. 3 long-distance company was forced to put up its valuable yellow-pages businesses as collateral to borrow $1 billion from banks.
• Tuesday, big equipment maker Lucent Technologies Inc. told analysts it doesn't expect to return to profitability until 2003, instead of this year.
• Prices are plummeting in the wireless industry as growth in the number of new users slows. AT&T Wireless Services Inc., the nation's third-largest wireless company, reduced its projections for 2002 on March 1, in part because the rise in the minutes of use isn't enough to compensate for the fall in prices.
"The industry can't survive this way," says Denny Strigl, chief executive officer of Verizon Wireless, a joint venture of Verizon Communications Inc. and Britain's Vodafone Group PLC. "The sooner we consolidate this business, the better."
Telecom revenues are still growing, but in the low-to-mid-single digits, a far cry from the double-digit spikes that enticed so many investors during the boom. And although the stocks of some companies have climbed back a bit recently, the Dow Jones Global Telecommunications Index is off 11% since the beginning of the year, compared to a 1.5% rise for the Standard & Poor's 500. In the past two years, investors have suffered $2 trillion in paper losses from a 60% drop in the sector's market capitalization, according to Dow Jones Statistics. Shares of WorldCom and Qwest are down more than 35% so far this year.
The fortunes of the bigger players have changed with striking speed. Until just recently, many executives were applauding the downturn, believing it would cut down on overcapacity and the glut of players, leaving the more established ones stronger. Joseph P. Nacchio, Qwest's chief executive, told investors that as new entrants had difficulties, there would be a "flight to safety" to companies such as Qwest.
But when fiber-optic carrier Global Crossing filed for bankruptcy-court protection in January, becoming the fourth-largest bankruptcy in U.S. history, many investors fled. Sitting on Credit Suisse First Boston's huge trading desk in Manhattan's Flatiron District in recent weeks, John Greco has scrambled to field a series of calls from worried telecom investors, eager to sell.
"People are petrified," says Mr. Greco, a senior trader. "They've lost so much money so quickly."
Many of the industry's current problems can be traced to overcapacity. Spurred by the Telecommunications Reform Act of 1996, which pledged to open the historically regulated industry to competition, the telecom industry went on a building binge. By the time the Internet bubble burst, an estimated 39 million miles of fiber-optic cable stretched underneath the U.S.; only 10% of it is in use today, according to the latest estimate by Merrill Lynch & Co.
The building binge also extended to dozens of upstarts providing alternative local phone and Internet service. Most have since gone under. And six national players in the wireless industry rushed to assemble cross-country networks that most agree created a glut of competitors.
Huge Debts
To pay for it all, telecom companies took on huge debts. Since 1996, telecoms have borrowed more than $1.5 trillion from banks and issued more than $630 billion of bonds, according to Thomson Financial, a data company -- topping all other industries.
By late last year, it became clear that growth was slowing significantly, thanks to overcapacity, price wars and slowing usage. For instance, WorldCom's fourth-quarter data revenue, once a reliable source of double-digit growth, was down more than 5% from the previous quarter, shocking some analysts who expected big gains.
The company's explanation: Businesses were spending less on communications systems. Company officials stress that WorldCom doesn't face a liquidity crunch. But the company's stock and bonds began to plunge, and credit-rating agencies lowered WorldCom's debt rating, citing worries about the growth of its business.
Other ratings cuts followed, and lenders quickly clamped down. Laurence Grafstein, head of global telecommunications investment banking at Lazard Freres & Co., who is working with a number of telecom companies, says banks are scrambling to reduce their exposure to the sector. Combined with the industry's price declines, he says, the impact "is equivalent to swimming against a tidal wave."
Howard Janzen, chief executive of Williams Communications Group, knows that feeling. Last month, he told investors that bankruptcy wasn't an option for the fiber-optic company. But three weeks later, after the company's team of 40 bank lenders turned down his appeal for more cash, he reversed course. He acknowledged that his company is now considering filing for bankruptcy-court protection in a restructuring that could leave shareholders next to nothing.
"Literally, in a week, the situation changed for us," says Mr. Janzen. In his more than 23 years in the industry building fiber-optic networks in and near gas pipelines, Mr. Janzen says he has seen lots of booms and busts, but never anything like this. "I would say people are panicking a lot," he says.
Since the collapse began more than a year ago, as many as 300,000 jobs have been lost. Last week, Verizon, one of the healthiest companies in the business, said it would eliminate the equivalent of 10,000 jobs this year, or 3% of its work force, because of slower growth. Qwest is selling its yellow pages to raise cash. In January, employees at WorldCom were told that a perk of $25 in free long-distance service a month was being eliminated.
Capital spending by telecom companies is expected to decline as much as 20% this year after falling 25% last year. That's a huge whipsaw from increases of almost 30% in 2000. This hurts gear makers such as Lucent and Cisco Systems Inc. Some economists believe that the telecom sector's troubles run so deep that they will act as a drag as the nation's economy starts to recover from last year's recession.
Consumers and businesses are taking longer to soak up the capacity built up in the last decade. Huge amounts of free wireless minutes on nights and weekends are prompting many consumers to cancel their traditional long-distance plans. Meanwhile, data traffic, once thought to be the savior of the industry, is growing more slowly than originally forecast, and it isn't nearly as profitable as old-fashioned voice calls. That's because users pay for data in bulk instead of per minute. This is why e-mail, which is replacing millions of calls a day, is considerably less profitable for telecoms than phone calls.
Brutal Competition
Price wars, which started in 2000 among the long-distance giants, have now spread everywhere. Brutal competition to lure big business contracts has brought down long-distance per-minute prices to as low as a penny a minute, though prices have recently increased for consumers who don't pay to be on a discount plan. Prices for data transport among the many fiber-optic companies have declined as much as 50% a year. In wireless, small regional companies, such as Leap Wireless International Inc., are offering unlimited calling in local areas for as little as $32 a month, with no charges for incoming calls. That puts even more pressure on the big players.
Meanwhile, flat-rate pricing is spreading, even to traditional services, as companies go for volume, perhaps over profits. AT&T, for example, recently unveiled unlimited long-distance calling for $19.95 a month between AT&T callers over land lines.
In wireless, expected to be the growth engine of the future, the competition has become unexpectedly cruel. Prices started plunging in the past year as companies raced to offer more minutes, with free calls on the nights and weekends. That was fine as long as explosive growth in the number of subscribers kept ahead of the price declines. In 2000, for example, the number of U.S. subscribers jumped 27%.
But in 2001, the growth slowed to 18% and is forecast to grow only 12% in 2002, according to Steven Yanis, a wireless analyst with Banc of America Securities. That has raised concerns about a saturation point because an estimated 46% of the U.S. population already had wireless phones by the end of 2001. Also sparking worries among investors is that prices on peak minutes, which had been relatively stable, have started eroding in the past month.
On March 1, AT&T Wireless seemed to underline such concerns by lowering its 2002 financial projections, in part because of pricing pressures. John Zeglis, the company's chief executive, says that for the first time, the growth in minutes of use isn't keeping up with the price decline.
Mr. Zeglis considers this a temporary hiccup in the market and points out that the industry's underlying growth is still sound, especially as e-mail and other data uses develop. But he says that consumers are also getting smarter about how they call, making sure they confine their calls to the number of minutes allotted to them and putting off many calls until nights and weekends.
Meanwhile, a more serious long-term problem lurks: Users are switching from traditional telecom services to less-profitable new technologies, such as the Internet. With so many free minutes, consumers are relying more heavily on their wireless phones. Many have completely given up their traditional long-distance plans. According to market researcher IDC, the number of wireless users who reported using their wireless phones at home increased by 40.9% from 1999 to 2000 and is even higher now.
As if the industry didn't have enough problems, there is growing concern that the financial results some telecom companies posted during the boom times are suspect.
Companies such as WorldCom, Global Crossing and Qwest all staked their reputations as brash new entrants by posting big, double-digit revenue increases quarter after quarter.
But as the telecom sector began to melt down, worries about the integrity of such numbers grew. Executives repeatedly assured investors that their balance sheets were solid as stocks swung back and forth on the concerns late in 2001. But the concerns intensified considerably after Global Crossing filed for bankruptcy protection.
Now, with word that the SEC is looking into WorldCom and Qwest, there is growing evidence that the industry's accounting woes could just be beginning. Qwest, for example, engaged in a series of swaps of fiber-optic capacity to enhance its revenue. WorldCom, the industry's most aggressive acquirer, could face questions as to whether its growth rates were fueled more by accounting treatment of its deals than by real growth of its voice and data traffic.
What has analysts most concerned is that some of the accounting moves seem to have occurred in 2001, just as it was beginning to become clear that double-digit growth rates were unsustainable. Analysts are bracing themselves for more revelations.
"It is basically Darwinian," says Jim Friedland, an analyst with Robertson Stephens. "Slowly but surely, the biggest players that didn't have any issues are starting to see issues pop out."
Write to Rebecca Blumenstein at rebecca.blumenstein@wsj.com and Gregory Zuckerman at gregory.zuckerman@wsj.com
Updated March 13, 2002 |
