Well, yes, it is, bigger, faster, and deadlier, for some, but not for others ...
In case the thread missed this one ...
WSJ May 11th, 2001
May 11, 2001
Page One Feature
Telecom Debt Debacle Could Lead
To Losses of Historic Proportions
By GREGORY ZUCKERMAN and DEBORAH SOLOMON
Staff Reporters of THE WALL STREET JOURNAL
Two years ago, when the Baltimore Ravens agreed to plaster PSINet Inc.'s
name on their football stadium in exchange for $105 million over 20 years,
the telecommunications upstart looked like a valuable player.
One of the first to offer high-speed Internet service to corporate America,
the Ashburn, Va., company was a Wall Street hero, with a market
capitalization soon to surpass that of American Airlines parent AMR Corp.
and Delta Air Lines combined. But PSINet's game plan didn't work out.
Crippled by its $3 billion debt load, the company warns it may seek federal
bankruptcy-court protection, a move one person close to the matter says may
come as soon as next week. That could force the Super Bowl champion Ravens
to line up with creditors seeking court approval for future payments.
1See a chart on 'Telecom Hangups'
2British Telecom Announces Plans to Split in Two to Reduce Debt
3IDT Scavenges for Bargains in Phone-Upstart Wreckage
4Nortel Dissolves Its DSL Division as Part of Ongoing Restructuring
As the epic telecom bust reverberates around the globe, it's getting to be a
very long line. Telecom companies, which gorged on some $650 billion in debt
in the past few years, are failing in record numbers for that industry. It's
shaping up to be one of the biggest financial fiascoes ever, with losses to
investors expected to approach the $150 billion government cleanup of the
savings-and-loan industry a decade ago.
"I don't know if there's a modern-day precedent for the billions of losses"
to investors from the telecom industry, says Greg Dube, head of global
high-yield investments at Alliance Capital.
What's unprecedented -- besides the staggering debt totals -- is how little
the assets of the troubled telecom companies will likely be worth as the
restructurings play out. Past bankruptcy waves, such as those that swept the
rail, retail, steel and movie-theater businesses, left bondholders with
about 40 cents on the dollar, while bank lenders usually got most of their
money back. But bond investors may not be able to salvage much more than 10
cents on the dollar from the telecom restructurings, with banks also taking
a hit, according to analysts. One reason: The industry's high-tech gear
becomes outdated at such a rapid clip.
The Boom Before the Bust
The bust had its origins five years ago, when Congress lifted restrictions
on who could sell voice, video and data services in the local phone markets.
Back then, the Internet and wireless services were in their infancies and
huge profits were expected. Hundreds of upstarts rushed to build
state-of-the-art networks to carry the expected surge of demand, and
incumbents such as AT&T Corp. and the Baby Bells also awakened to the
opportunity, investing billions in their own wireless and Internet
businesses. Investors rushed to supply the cash, and Wall Street firms have
made $7 billion in fees by raising debt and equity for the companies since
1995. But the demand didn't materialize as quickly as expected, and the Baby
Bells proved to be tough competitors for the upstarts. Today, more than 97%
of fiber-optic capacity goes unused.
The debt troubles have spread to every sector of the telecommunications
industry. Firms that spent the past few years digging up streets, highways
and ocean floors to build fiber-optic networks, such as Level 3
Communications Inc., are burning through hundreds of millions of dollars
each quarter. Local phone companies, such as Winstar Communications Inc.,
have filed for bankruptcy protection, while wireless phone companies,
including Nextel Communications Inc., and a slew of high-speed Internet
providers have all seen their stock prices plunge, as heavy debts crimp
profits.
And the damage goes far beyond the telecom upstarts. Heavy debts will likely
hound blue-chip companies like British Telecommunications PLC and AT&T for
years to come. What's more, the troubles will likely weigh on the overall
growth of the economy for the next several years because the telecom sector
has become so big.
How painful will the shake-out be? In the past six months, about 10 telecom
providers have filed for bankruptcy. By the time it's over, dozens more may
have to be restructured or seek bankruptcy protection, according to
analysts. The big losers: bond investors, banks, stock investors and
venture-capital firms, all of whom are already seeing their investments
tumble in value.
Holders of U.S. and European telecom bank loans currently face more than $30
billion of losses, according to S&P Portfolio Management Data. Bond
investors are sitting on paper losses of about $40 billion of their own,
while stock investors have seen $20 billion in losses from purchases of
initial public offerings -- not even counting the $500 billion in paper
losses stemming from the 40% plummet in the sector's market capitalization
from the peak. Venture-capital firms have $20 billion or so in telecom
losses and investors in debt securities convertible into stock have dropped
another $5 billion, according to analysts.
As bad as this debt debacle is likely to become, however, it's not likely to
spread into a broad financial crisis. Because of changes in the bank-loan
and debt markets, this huge amount of telecom borrowing isn't concentrated
in the hands of a few financial institutions, as was the case in the Latin
America debt crisis of the early 1980s. Mutual funds, pension funds and
other institutional investors have loaded up on a wide variety of debt, and
their losses on junk bonds issued by telecom companies have been partially
offset by gains elsewhere in their portfolios. Investors will take a hit,
but most won't take a devastating hit.
Major banks nowadays don't keep huge pieces of loans on their books but
instead break them into pieces among dozens of other banks and investors. So
J.P. Morgan Chase & Co., for instance, which originated some $152 billion in
global telecom loans last year, has less than 10% of that on its own books.
Swift and Severe
Still, the industry's shakeout is already shaping up to be unusually swift
and severe. Northpoint Communications Group Inc., founded in 1997, raised
$1.2 billion selling stock and bonds to build high-speed lines to sell to
Internet-service providers and corporate customers. A year ago, the San
Francisco-based company was valued at $6 billion. It filed for Chapter 11
bankruptcy-court protection in January, however, after a takeover offer for
the company was withdrawn and Northpoint failed to sign up enough customers
to cover its huge debt burden.
When its assets were offered to bidders earlier this year, interested
parties were scarce. One problem is that Northpoint provides essentially the
same service as Covad Communications Group Inc. and Rhythms NetConnections
Inc., both of which are struggling financially and could eventually have to
sell assets.
In the end, the highest bid came from AT&T, which paid just $135 million for
dozens of metal cages containing racks of high-speed Internet equipment that
Northpoint had installed in the central offices of the Baby Bells. That's
just about half the amount Northpoint spent on the gear over the past three
years. On their way out the door, employees are being invited to buy their
own computers for hundreds of dollars, according to a Northpoint executive.
Investors who purchased $400 million in bonds will receive almost nothing,
while shareholders won't be getting a penny.
Why is the wave of restructurings likely to result in such puny recoveries,
especially as many of the firms sit on state-of-the-art equipment that's far
better than anything on the market just a few years ago? For starters, many
of the struggling telecom companies never became fully formed businesses.
PSINet, for example, never integrated many of the 74 smaller companies it
purchased in recent years. Lacking a solid customer base, many of the
upstarts have little hope of becoming profitable in the near future.
"These telecom companies are worth substantially more as ongoing businesses
than in liquidation," says Aryeh Bourkoff, a telecom analyst at UBS Warburg
LLC.
Most surviving telecom companies have virtually all the equipment they need,
so there are few buyers for high-tech gear on the auction block. Those who
are looking for distressed assets have a wide swath of companies to choose
from and can often get that gear on the cheap.
High-Tech Yard Sale
Indeed, so much used telecom equipment -- such as billing systems, switches
and hardware that routes phone and Internet traffic -- is flooding the
market that it's looking like the world's biggest yard sale, with much of it
selling for 20 cents or so on the dollar. Racks and cages, which companies
like PSINet use to hold the servers that power Web sites, sell for about
$100, down from about $1,000 six months ago. New equipment still in its
original packaging is even showing up on the used equipment market.
Last month auction site DoveBid.com auctioned off almost all the assets of
Pacific Gateway Exchange, a Burlingame, Calif.-based telecom provider that
filed for Chapter 11. Up for grabs were Cisco routers, Nortel phone
switches, Dell servers, fax machines and LaserJet printers, most of which
sold for less than 50 cents on the dollar. One server, which retailed for
around $6,000 18 months ago, was auctioned off for about half that.
Another reason there will be big telecom losses: Many investors and lenders
who specialize in distressed companies, and sometimes supply them with
additional capital during a restructuring, are steering clear of the sector.
While troubled companies in the past -- such as R. H. Macy & Co. and
Federated Department Stores Inc. in the early 1990s -- had loads of debt but
at least had operating profit, most troubled telecom providers have little
in the way of revenues, making them riskier investments for the specialists.
"Manufacturers or retailers had clear values for their assets, [but] if
telecoms go bad recoveries can be de minimus," said Bruce Karsh, a veteran
distressed-debt investor at Oaktree Capital Management in Los Angeles.
"Northpoint gives everyone pause, because AT&T's bid was a very rock-bottom
price."
But the upstarts need cash as much as ever. Many need money to finish their
networks and meet interest payments until they begin generating profit. With
investors and lenders turning a cold shoulder to many telecom companies,
more will go under in the next year unless they can somehow come up with the
funds to meet debt payments. And with stock prices of many telecom companies
down, few acquisitions of the debt-laden telecom providers are likely.
In fact, financial pressures on many telecom providers are only getting
worse. Many big companies, including XO Communications Inc., McLeodUSA Inc.
and Level 3 Communications, sold so-called discount notes that haven't yet
required any cash interest payment. As much as $31 billion of these
securities have been sold in the last five years, a third of all junk-bond
sales by telecom providers. Over the next three years, a number of these
companies will have to begin making new interest payments totaling $3.9
billion -- putting added pressure on the companies.
"We are approaching the period when the chickens come home to roost,"
according to a recent report about the notes from Moody's Investors Service.
McLeodUSA, Level 3 and XO Communications all say they'll have enough cash to
make interest payments on the discount notes as they become due.
Meanwhile, even the nation's biggest long-distance company, AT&T, had to
slash its dividend and sell assets to conserve cash and help pay interest
expense on heavy debts from years of acquisitions.
Among the worst off of the big players are European telecommunications
companies, including Deutsche Telekom AG, France Telecom SA, the
Netherlands' Royal KPN NV and others, which together have spent more than $1
00 billion for so-called third-generation licenses to provide wireless data
services. But the European rollout of "3G" won't happen for several years.
Moody Investor's Service recently reiterated its negative outlook on the
European telecom industry, saying cash flow from 3G "is very uncertain, both
in terms of amounts and timing." And the companies will have to spend an
additional $100 billion or so just to get the wireless networks operational.
British Telecom, buckling under its $43 billion debt burden, Thursday
announced a sweeping plan to spin off its wireless business, halt dividend
payments and raise cash through a giant equity offering.
For the upstarts the outlook is worse: A series of restructurings is likely,
either in bankruptcy or outside, with bond investors and banks assuming the
reins of the most competitive telecom companies, shooing the entrepreneurs
who started the companies out the door.
First In Best Off?
The first companies to file bankruptcy may turn out to be the best off.
Several telecom providers, including ICG Communications Inc., are in
bankruptcy protection and in the process of shaving debt, cutting expenses
and cleaning up their balance sheets. That may give them a leg up over even
bigger rivals that suffer from heavy debt payments. "The surprise winner
will be ICG, even though they were the first and biggest to go down," says
Ethan Garber, an analyst at Lehman Brothers Holdings Inc.
That isn't to say the process hasn't been painful. Bondholders in ICG, which
filed for bankruptcy in November, will probably get little more than shares
in the restructured company for their $3 billion in securities. The
company's lenders will also see big losses. Otherwise savvy investors such
as John Malone have seen their reputations tarnished; his Liberty Media,
which invested $500 million in ICG, recently sold its stake for an
undisclosed sum to IDT Corp., another telecom provider. And almost half of
ICG's 2,600 employees have been fired.
Still, ICG is expected to emerge from bankruptcy around the beginning of
next year with many of the same customers and a clean balance sheet,
enabling the company to undercut prices of rivals struggling to pay interest
expenses on big debts. "Some of our brethren would have a better chance of
surviving if they reorganized quicker," says Randy Curran, ICG's chief
executive.
PSINet's Outlook
The outlook may not be so rosy for PSINet. The company took on mountains of
debt and went on an acquisition spree even though big profits were years
away. It built up Web-hosting centers in major cities including New York,
Los Angeles and London. Even as some members of the company's board of
directors expressed concern about the debt, PSINet's chief executive,
William Schrader, "was more interested in building the infrastructure than
in achieving profitability with what he already had," says Ian P. Sharp, a
PSINet board member. With so much money available, Mr. Schrader wanted to
get it before his competitors, according to Mr. Sharp. Mr. Schrader didn't
return calls seeking comment. PSINet declined to comment.
A year ago, when rival telecom companies contacted Mr. Schrader, to see if
PSINet was willing to sell itself, Mr. Schrader demanded a price far above
anything they were willing to pay.
"When the stock was at $30 he'd say 'I'm a seller at $75.' When it went to
$60, he said 'I'm a seller at $100,' " said a person close to PSINet.
Mr. Schrader was sure his firm would be a survivor. At PSINet's holiday
party in December, he told employees: "AT&T is going to go down, but PSINet
will survive," according to a former PSINet executive who was there.
By September, PSINet's debt load was hurting, sales were off and the company
was dealing with big costs just to keep its business running. Sitting in his
Cherry Hill, N.J., office, watching PSINet's bonds begin to lose value in
the summer, Eric Green, head portfolio manager at Penn Capital Management
LLP, became concerned. After making some calls to people in the industry,
and hearing what Mr. Schrader was asking for the company, he began dumping
his own PSINet bonds.
Last month, PSINet reported a $3.2 billion loss for its fourth quarter and
said it had defaulted on several loans. The company said it's "likely that
the common stock of the company will have no value."
On April 29, in a hastily arranged afternoon conference call, PSINet's board
members asked Mr. Schrader to resign. He offered no resistance.
In the end, the company's debt discouraged potential acquirers, says Mr.
Sharp. "You have companies like PSINet with a large amount of debt," he
says. "Nobody in their right mind is going to step up and say 'I'll take
that debt and buy the company.' "
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com5 and Deborah Solomon
at deborah.solomon@wsj.com6
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