This thing is on the move all right: DOWN. Seen this? ""Pacific Overtures Can undersea cable live up to Wall Street's expectations? By Bill Alpert
Calling your mom just gets cheaper by the day, whether she's in Dubuque or Dublin. Wonderful, right? Not if
you're in the long-distance phone business. While AT&T fights its consumer calling war against Sprint and MCI
WorldCom on the ground, a submarine battle has sunk the price of
transoceanic calls and the undersea cables that carry them. Cable pricing has
plunged 90% in the past 18 months, capsizing business plans and stock prices
of firms such as Global Crossing, which had to ante up more shares of its
stock last week to ensure its $10 billion purchase of Frontier Corp.
The pricing plunge has also squeezed Pacific Gateway Exchange, the
Burlingame, California, bellwether of the international long-distance business.
Unlike Global Crossing, Pacific Gateway has real profits, from its wholesaling
of international phone service. But competition has eroded its margins, and its
Nasdaq-traded shares have sunk from $50 to $20, even though some Wall
Street analysts say its interests in undersea cables are worth up to $50 a
share.
But evidence from Pacific Gateway's recent sale of some of those cables
discloses a big problem: Between April and July, Pacific Gateway's sale price
for its transatlantic capacity seems to have slipped sharply.
Worse yet, new accounting rules that took effect in July will make it almost
impossible for firms like Pacific Gateway, as well as biggies like Global
Crossing, IXC Communications and Williams Communications Group, to
continue booking big revenues and profits from fiber sales.
Howard A. Neckowitz founded Pacific Gateway in 1991 to wholesale
overseas connections to U.S. phone firms. As one of the most efficient
international wholesalers, Pacific Gateway boosted sales to $466 million in
1998, with earnings of $20 million, or 97 cents per share. The company
bought into consortiums that should complete fiber links across the Atlantic
and Pacific oceans by 2001. After spending about $260 million, Pacific
Gateway will get about 500 subsea circuits known as STM-1 lines -- each
capable of carrying 155 megabits of traffic per second. That's a lot. An
STM-1 equals about 100 of the corporate connections known as T1 lines.
Owning fiber should trim Pacific Gateway's costs -- and not a moment too
soon. Since September 1998, competitive pressure in the international
long-distance market has squeezed gross margins from 16.2% to a June '99
level of 13%. Wholesale service for U.S.-based phone firms still accounted
for 79% of June '99 revenues, and operating profits in that business segment
dove 87% to just above breakeven. The firm has guided Wall Street to
expect a drop in year-over-year earnings, with the consensus now at 81 cents
a share for 1999, according to First Call. (Although Neckowitz scheduled
and rescheduled a phone interview with Barron's last week, he never came
through.)
As the wholesale calling business has suffered, Wall Street has turned its gaze
to Pacific Gateway's ownership of undersea fiber. For $156 million in direct costs, plus another $100 million in
land-based hookups, the company will
own almost 300 STM-1 links beneath the Atlantic and the Pacific. That
represents an all-inclusive cost of about $500,000 per Atlantic link and
$900,000 per Pacific link. Assuming that Pacific Gateway could resell those
STM-1 circuits for a couple of million bucks each, analysts like Jack
Grubman at Salomon Smith Barney have insisted that Pacific Gateway's cable
assets were worth $35-$50 per share.
But the same deep-sea pressure that's crushed calling prices has crushed the
resale price of cables. Underwater bandwidth is exploding, as a result of
capacity-boosting technology and proliferating cable ventures. However, the
much-expected explosion in broadband demand is not within earshot.
Itzhak Fisher, CEO of the
international carrier RSL
Communications, admits to
happy surprise at sliding
transmission-capacity prices.
When he and cosmetics heir
Ronald S. Lauder started
RSL five years ago, the annual
lease of a T1 line to London
cost $250,000. Last year, that
sum could buy one.
Jefferies & Co. analyst
Gregory P. Miller correctly
called the plunge in cable prices. He writes that a transatlantic STM-1 line's
cost has slipped from $12 million in early '98 to about $1 million today.
Cable resales announced this year by Pacific Gateway suggest that the
slippage continues. In April, the firm announced the sale of 17 STM-1 lines to
Williams Communications for $30 million, about $1.8 million each. Last
month, Pacific Gateway disclosed the sale of another 5% of its Atlantic fiber
-- which would be about 25 STM-1 lines -- for $35 million, suggesting that
prices have fallen below $1.4 million per line, or 22% in three months. Pacific
Ocean prices have been stronger, but the Southern Cross cable system just
dropped its Australia-to-U.S. STM-1 price from $37.8 million to $12.9
million, and its Hawaii-U.S. mainland price from $6.2 million to $1.4 million.
Pacific Gateway told Wall Street to expect $1.30-$1.50 per-share profits
next year, just from announced cable sales. However, only part of those sales
were for cash. The spring deal with Williams, for instance, is actually a swap
of Pacific Gateway undersea circuits for land-based circuits that Williams
owns. And Pacific Gateway's June '99 10Q suggests that most of the $35
million in summer fiber sales were also swaps.
To book profits on those non-monetary exchanges is akin to an Internet firm's
booking profits on the exchange of banner ads with another Website. Other
fiber owners haven't done that. Austin, Texas-based IXC Communications
reported $47 million in revenues from fiber exchanges in the three years
ended 1998, but booked no profits on them, after assuming that those
revenues equaled the cost of the fiber it had traded away. In an exchange of
several hundred million dollars worth of transmission capacity with Williams,
the wireless telecom firm Winstar Communications won't recognize all the
revenues for 25 years.
Historically, much of the industry accounted for such deals as sales -- explains
Williams Communications' financial chief, Scott Schubert -- even though legal
title to the fiber didn't change hands. But July was the effective date of the
Financial Accounting Standards Board's new interpretation of such deals,
requiring title transfer for revenue to be booked in one shot. Past results
needn't be restated, but without title transfer, the FASB and the SEC now say
that revenues and profits from fiber sales must be reported piecemeal over the
life of a deal, like a lease.
Plenty of other firms have been recognizing fiber sales revenues all at once.
Among them: PSINet, Qwest Communications, and Europe's Carrier 1
International and Viatel. Going forward, Pacific Gateway will have a tough
time supplementing its other sales and earnings with fiber deals. This might
have been a factor in what the company's 10Q calls the "lapse" of a letter of
intent by investment firms to raise $200 million for Pacific Gateway.
Pricing and accounting issues loom even larger for Global Crossing. The firm
has historically recognized all the revenues from a 25-year fiber deal when the
fiber lit up for service.
Global Crossing reported gross margins of 56% on its $183 million in
transatlantic capacity sales for the June '99 quarter. But it calculated those
profits by forecasting the "total expected capacity revenues over the life of the
system." Those forecast revenues, says Global Crossing in footnotes to its
10-K, are based on a third-party consultant's market forecast, "updated on
an annual basis." A consultant's market study also establishes the balance
sheet value for Global Crossing's segments under construction -- some $842
million worth as of June.
With STM-1 prices dropping through the ocean floor, any 25-year forecast
seems tenuous in computing earnings. If prices can fall 22% in a quarter, how
credible is a forecast that's updated "on an annual basis"?
Barron's asked Global Crossing what price per STM-1 the market study
assumed. "The information that you are seeking is considered proprietary
information," a spokesperson curtly replied."
I mean those are real companies, UTCC pales in comparison. |
