Telecoms slump leaves questions about revenues. "Internet doubling every three months" and bandwidth exchanges have been thrashed as the bankruptcy of transport carriers is showing.
FTTH is the next mirage to be dealt with. Also Watch for the other shoe to drop: undersea intercontinental over capacity.
Telecoms slump leaves questions about revenues
By Richard Waters in New York and Dan Roberts in London
Published: February 12 2002 20:21 | Last Updated: February 12 2002 23:10
Was there a hollow at the heart of the global telecommunications industry during the boom of the 1990s? That is the latest disturbing question to emerge from the hunt for accounting irregularities that is now in full swing on both sides of the Atlantic.
Many telecoms companies traded with each other, exchanging capacity on each others' networks, and treated their trades as revenues. But some of those deals may have been "hollow swaps", artificial deals concocted merely to create the illusion of activity, according to a growing chorus of industry analysts.
That suspicion has now attracted the attention of the Securities and Exchange Commission and the Federal Bureau of Investigation. Acting on a tip-off from Roy Olofson, a former finance executive at Global Crossing, both agencies are now studying that company's books. Global Crossing filed for bankruptcy protection two weeks ago in the biggest collapse to have yet emerged from the once-booming telecoms industry.
The SEC has also asked for information on Global Crossing's dealings with another US carrier, Qwest Communications - although Qwest points out that the inquiry is related to Global Crossing's accounting practices, not its own methods.
In Europe, the extent of the swapping is only now becoming apparent as the number of different operators shrinks due to bankruptcy and consolidation. On Tuesday, Carrier1 became the latest in a long line of so-called alternative carriers to seek bankruptcy protection in Europe.
Carrier1 was forced to abandon debt restructuring plans when many of the networks providing it with capacity lost confidence in its ability to pay. Mike McTighe, Carrier1's chief executive, says a big factor behind this collapse in confidence was concern about how telecoms companies account for revenues.
The extent to which telecoms companies have been relying on each other for business was also highlighted on Tuesday by KPNQwest, which is usually regarded as one of the stronger European operators. Jack McMaster, chief executive, revealed that 15 per cent of its revenue was from selling capacity to telecom networks that also supplied it with capacity.
Mr McMaster insists all such deals were struck at fair market prices, but KPNQwest's ability to book the revenue from such long-term swaps immediately has led analysts to question how long it can continue to show growth when so many "customers" are going into bankruptcy.
This intense scrutiny of the telecoms industry is the latest sign of the doubts about corporate reporting that have sprung up in the wake of the Enron collapse. Despite the concerns, there is no hard evidence yet of how widespread any abuse might have been, and the vast majority of transactions may well have been conducted for genuine business reasons. But that has not stopped questions proliferating.
The craze for swaps in the telecoms industry traces its roots to the emergence of the internet as a mass-market medium in the mid-1990s. It was certainly a frenzied time: the internet was growing fast and carriers such as Global Crossing, Qwest Communications and Level 3 were rushing to assemble the "backbone" networks needed to carry internet traffic around the world.
Though many of these companies had global ambitions, few had the resources to build a complete global communications network. To fill the gaps, that meant buying capacity in bulk on another company's network. The purchases usually took the form of long-term leases known as IRUs, or indefeasible rights of use - and were often paid for through a "swap" arrangement that involved handing over network capacity in return.
One important effect of these transactions was to boost the revenues at both companies, since the swaps were recorded as sales. For an industry that was becoming desperate for revenues, that was a boon. Upstart telecoms companies had each ploughed billions of dollars into laying fibre, only to find that too many networks had been built. To make matters worse, a slowing global economy meant that internet growth began to ease.
The late development of European networks compared with the US led to an even greater reliance on "swapping" capacity. Operators that had barely begun to build pan-European networks at the start of the internet boom sought to present a seamless service to customers by filling in the gaps with leased capacity.
This was a huge opportunity for the one or two US-inspired pioneers such as GTS and MFS that had gambled heavily by building spare European capacity. In the scramble that followed, it became almost impossible to tell how many genuinely pan-European networks had been created. Analysts complained of seeing the same maps of network coverage in the annual reports of a number of companies, many of which were simply leasing capacity from the same owners.
However, this confusion became an advantage once the bubble began to burst. Companies struggling to meet their growth targets found it was possible to continue generating healthy "revenues" by selling capacity to each other.
It all bears a striking similarity to the early days of the dotcoms, says one person familiar with the reviews now under way into accounting practices in the telecoms industry. Young dotcom companies also raised capital in anticipation of a boom in demand for their services. Like the telecoms companies, they also came to rely heavily on revenues as a measure of performance: since they had no earnings, investors had little else to judge them on.
To generate sales, many dotcoms relied on transactions with each other, placing advertising on each others' websites and booking the resulting income as revenues. Those circular transactions dried up when the dotcoms could no longer raise capital. With hindsight, it appeared that many of the mutual advertising deals had had little business purpose, or had been done at artificially inflated prices.
The problem now in the telecoms business is disentangling the bona fide business dealings from the artificial. "Companies in effect swap revenues all the time," says Jim Crowe, chief executive of Level 3 Commnications, one of the new telecoms companies. "It's a perfectly legitimate engine of commerce, it's how business is done."
But such arrangements are not justified when they lack economic substance. An example might be a company agreeing to buy capacity on another's network that it did not need, merely to support a sale of its own network capacity. Alternatively, the price at which the two blocks of capacity were traded could have been set artificially high to boost revenues. Mr Crowe says that such hollow swaps will almost certainly be unearthed.
Investors are also likely to cast a careful eye over how telecoms companies account for revenues. One company now under scrutiny is the UK group Cable & Wireless, which has booked revenue immediately from long-term capacity leases. The company says this practice is clearly allowable under UK accounting standards. Many accountants feel that UK standards need to be tightened up, as occurred in the US two years ago.
Yet even in the US, tougher accounting rules and more disclosure did little to cool the enthusiasm that investors felt for the new breed of global internet communications companies at the time. Adam Quinton, an analyst at Merrill Lynch points out that, after US companies began to report their figures under more cautious rules, investors preferred to keep looking at "cash earnings", which reflected the former standards.
In the end, investors may find that they were as much to blame for turning a blind eye to how telecoms companies accounted for their revenues in the boom days as anyone. The beauty of the sector was at least partly in the eye of the beholder. |
