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To: Johnny Canuck who wrote (36071)	2/3/2002 8:22:03 PM
From: Johnny Canuck	Read Replies (3) \| Respond to of 68187

The Strong Will Survive the Fallout in Telecom February 3, 2002 By KENNETH N. GILPIN anuary was a grim month for telecommunications companies. In rapid succession, Global Crossing Ltd. (news/quote) and McLeodUSA (news/quote) filed for bankruptcy protection. Williams Companies (news/quote) said it was re- evaluating its debt exposure to Williams Communications Group Inc. (news/quote), which it spun off last year, and WorldCom Inc. (news/quote)'s stock took a tumble. Adam Quinton, head of global telecommunications research at Merrill Lynch (news/quote), talked last week about the industry. Following are excerpts from the conversation: Q. How big of a problem is overcapacity for telecommunications companies? A. From 1996 to the end of 2002, the number of competitive local communications companies increased by about a factor of three, to around 600. A lot of these are small companies that have businesses that are not viable and weren't viable whether they borrowed too much money or not. We are pretty much at the tail end of getting rid of those. But there is still the legacy of the over-investment phase. And if the industry had invested relative to its revenues at a level consistent with the early and mid-1990's, we would have seen something like $50 billion less spent on telecommunications equipment than we saw. Q. Is the Telecommunications Act of 1996, which deregulated the business, responsible for today's problems? A. You could cite the telecom act as helping to contribute to a pretty uncomfortable end result. Without the 1996 act, new entrants would not have been able to come into the market as they did, even if the capital markets had wanted to finance them. But the telecom act is only one part of what was a pretty heady cocktail. Q. How long will it take to unravel this mess? A. From a purely mechanical point of view, the recession we have seen has been good, because it has forced out a lot of weaker players and prohibited others from starting up operations. As far as recovery is concerned, it is interesting that some of the large companies say they see the economy continue to deteriorate into the first quarter. Recently, ATT, Qwest and Verizon all said pretty much the same thing: life isn't getting any better and may be getting worse. Q. Do you think some of the new companies, like Level 3 Communications (news/quote) and Williams Communications, will survive? A. Liquidity at Level 3 and Williams is currently pretty strong. The questions are, Can they manage their costs and is there enough growth in the market? On a very short-term basis, growth continues to be very weak. Because these are such new companies, it is not clear what capital they need to invest simply to maintain the system. These companies are new business models using new technology. Q. Will conditions improve for the larger companies, even though some of them are gloomy now? A. 2002 is an important year, because it will be the year when larger companies get their cash flow back in a healthy position. Cash flows at these companies will be positive. That is a signal to investors the industry is no longer killing itself by over-investing and bleeding to death. Q. Is it fair to say that investors should forget about turbocharged growth for this business? A. The telecom industry has a history of growing faster than nominal gross domestic product. It has consistently found more ways to take a dollar out of your pocket. The craziness of the 1998-2000 period was the belief the industry had a new paradigm. I don't see any reason why we don't revert to a more traditional reality. It won't be as exciting, but the people who are left in the business will be able to meet their obligations, and investors will have what they have had in the past: growth utilities. Q. Do you see value at the moment in any of these stocks? A. There is some value in telecom, but it tends to be in large local phone companies, not the smaller ones. The larger companies have the scale and scope to succeed, and there are no more than seven or eight of those. Currently, we like Verizon and BellSouth (news/quote). Both companies are improving their cash flows. Verizon is trading at about 14 times earnings, BellSouth at about 16 times. And Verizon has a dividend yield of a bit over 3 percent, which is quite nice. Worldcom is an interesting situation. The stock has had a pretty bad couple of days. I have consistently said I favor the local companies over the long-distance companies and that continues to be the case. But at these price levels, Worldcom could be a company that benefits more than others of its peers if the economy turns around fast. But that is not a bet I am prepared to make.