Telecom mess even worse than Enron
By GRETCHEN MORGENSON
THE NEW YORK TIMES
Tuesday, March 26, 2002
Thanks to a star-quality cast, the Enron wreck has been riveting theater. Greedy executives concocting transactions to inflate company earnings, grasping Wall Street bankers eager to assist, pliant accountants and analysts looking the other way -- Broadway's finest could not have come up with a better script.
While all eyes remain on Enron, a tragedy of identical plot but with far more damaging implications has been playing out on another stage. Unlike Enron's saga, this drama is not about a single, rogue company operating to enrich its executives, but about an entire industry: telecommunications.
It rose to a supposed value of $2 trillion based on dubious promises by Wall Street and company executives of an explosive growth in demand for telecommunications services. When that demand failed to materialize, the companies were left with mountains of debt and little revenue.
Now, securities regulators are examining transactions among some telecom companies -- Global Crossing and Qwest Communications are two -- that may have been designed to pad inadequate revenue. Last week, Congress, too, started an investigation of the telecom mess, looking at how certain companies accounted for the deals they struck with one another and whether employees in the companies' 401(k) plans were treated fairly.
As they dig, they may discover a trait that distinguishes this financial mess from others: the role played by an extensive web of relationships among these companies. Because of many deep and tangled ties, telecom companies were able to show what looked like promising growth in the mania's initial stages. But when one company failed, other failures became almost inevitable.
It is unclear whether many of these interlocking relationships served any economic purpose. What is clear is that executives had incentives to make them: by creating revenue, they helped keep the stock price up.
There is no doubt that the mess is large.
Since the telecom sector peaked in the spring of 2000, about $1.4 trillion in paper investor wealth has evaporated, according to one analyst. More than 15 companies have filed for bankruptcy reorganization in the past year or so, including former high fliers such as Global Crossing, which made the fourth-largest bankruptcy filing in American history in January, as well as 360 Networks, PSINet and Net2000 Communications. Many others in the industry are teetering.
Even companies that seemed solid and well diversified have been hurt. Lucent Technologies and Nortel Networks, both generous financiers to upstart telecom companies that bought their equipment, have had to write off billions of dollars in bad debts associated with their customers' failures.
Almost 400,000 jobs in the telecommunications sector have vanished as well, according to Challenger, Gray & Christmas, the job-placement concern. And the bloodletting is not slowing: Telecom companies cut about 61,000 jobs in the first two months of 2002, up 42 percent from the toll during the comparable period last year.
"The underpinnings of the emerging telecom bubble were a phenomenal miscalculation," said David Barden, a telecommunications analyst at J.P. Morgan. "At the time it seemed like a logical progression of history: cellular, the Internet, the new thing. It was bold, it was risky, it was expensive. And it was wrong."
Executives and shareholders lucky or prescient enough to get out early got rich as their companies' shares rocketed. Joseph Nacchio, chairman of Qwest, and Philip Anschutz, the co-chairman, have sold shares worth almost $2.3 billion since 1998. And James Crowe, chief executive of Level 3 Communications, sold $115 million worth of stock from 1999 to 2001.
"This, in part, set the stage for this massive transfer of wealth to the new telecom barons, not only from gullible investors, but banks and lenders who presumably should have known better," said Paul Elliott, an analyst at Thomson Financial.
Workers and shareholders who did not get out were left without chairs when the music stopped. In the 401(k) at Qwest, for example, almost 40 percent of the assets were in Qwest stock at the end of 2000, the most recent filings available. Since then, the shares have lost almost 80 percent of their value.
The telecom turmoil isn't over. Two years after the bubble popped, many companies in the industry are still operating on the edge, even more heavily encumbered with debt as a portion of capitalization than when their stocks were flying high.
As a result, in recent months, Qwest, WorldCom, Sprint and AT&T have sharply reduced their operations, staffs and earnings forecasts. Smaller companies such as XO Communications -- on which Seattle-area billionaire Craig McCaw lost nearly all of his estimated $5 billion investment -- and Level 3 Communications are struggling to restructure the terms of their debt obligations to stave off bankruptcy. Just last week, Metromedia Fiber Networks warned that it might file for bankruptcy soon. [Note: The amount McCaw lost has been changed since this article was originally published.]
Regulators, meanwhile, are focusing their investigations on how telecom companies accounted for certain transactions in which competitors swapped capacity on their networks. At issue is whether companies artificially inflated their earnings by striking deals that had no economic value but that appeared to produce immediate revenues.
As the accounting for some transactions is being questioned, these relationships are causing more problems for telecommunications companies.
Two weeks ago, Qwest announced that it had been contacted by the Securities and Exchange Commission regarding its accounting treatment of long-term contracts it had struck to sell capacity on its high-speed voice and data networks to Global Crossing, whose accounting is also under investigation. Both companies say their accounting methods are proper.
Such swaps continued to be struck across the industry as recently as last year, long after the bubble began to lose air. Kalla estimates that telecom companies made swaps worth $2.5 billion in 2001. It is not yet clear how many of those swaps lacked a real business purpose. But some analysts wonder if these interlocking relationships were intended to overstate the true economic value of the businesses. Given that the companies were not generating nearly enough revenue to keep investors happy last year, there was certainly incentive to inflate results.
Bad as things have been in telecom, the worst may not be over.
"Many of these companies have been through multiple rounds of layoffs, yet the industry is leading the way in 2002," James Challenger, the outplacement authority, said.
"This suggests that the excesses of the late '90s have yet to be purged." |
