Tim Wood in New York
Telecommunication stocks have fallen hard and fast, just like their media and technology cousins. It is now common cause that these stocks were more vulnerable to the business cycle than their management and promoters had believed, or let on. But telecom stocks promise the most pain.
As the United States economy slowed from May last year, taking its trading partners with it, inventories that had once turned over countless times in a year began to back up. Hardware companies were hit first as failing Internet companies began to dump equipment on the market for 10c or 20c in the dollar.
Those ailing firms were also customers of the telecom companies and the loss of that income forced a cut-back on capital spending, which, in turn, took the rug out from under networking and equipment suppliers.
It was all already too late. Production taps were added to and opened wide to cater to apparently insatiable demand for storage, processors, bandwidth and routing and switching devices. A global boom in Y2K tech spending had exaggerated demand and attracted hundreds of companies into the market with dozens of start-ups competing head-on in every niche.
Allied to that was the overstated anticipation of a shift to a new economy a term too loosely interchanged with the Internet that would force a permanent reappraisal of traditional factors of production.
While many Internet start-ups are the most egregious examples of the past three years’ excesses, telecom stocks may yet top the list of villains.
Telecom companies, usefully cloaked by the respectability and stability of a century of operations, slipstreamed the tech bubble rather effectively, persuading not only investors to buy their shares at high multiples, but staid institutions to loan them vast sums. The borrowings were to pay for spectrum licences and equipment to take advantage of broadband services that were supposed to grow as fast and more profitably than the AOL subscriber base.
It became apparent in September last year that telecom debt was developing into a hot spot as spreads widened and more and more issues began to attract junk bond status. Ratings agencies downgraded their outlooks, the surest sign of trouble ahead. There’s little room left to deflate the telecom stocks, but defaults will crack the financial sector.
PSINet, one of a coterie of “new” telecom companies, has set the alarm bells ringing for a full-scale conflagration. It has called in its bankers, Dresdner, to restructure its debt and credit obligations.
The last time the company reported (September 30 last year) it had $3,6-billion in debt. That was equal to 94% of its entire market capitalisation at the time. Since then the stock has fallen 99% to just one-eighth of a dollar. At its apogee in February last year PSINet was worth nearly $10-billion with each share changing hands at $50.
The term “restructure debt” is really just a polite way of saying “we’re stuffed, take cover!” The company almost said as much in an announcement where it warned shareholders: “Even if PSINet restructures its obligations or finds a buyer, PSINet’s common stock likely will have no value and the company’s debt will be worth significantly less than face value.”
PSINet bought the land-grab culture hook, line and sinker the same philosophy that pushed Primedia’s Metropolis to the brink. PSINet tried to build an empire buying other companies with its inflated stock and goosing cheap loans out of the market with promises of exceptional returns. The problem was that it bought bum companies and its last two Metamor Worldwide and Xpedior scuttled the ship.
Communications companies have bought themselves poor, just like most of their tech brethren. Repeatedly issuing new stock in large volumes is sustainable only if multiples keep rising. It becomes an infinitely accelerating treadmill.
The bubble treadmill was satisfied with revenue growth, but debt cannot be repaid with anything except cash flow. The post-bubble treadmill is all about earnings and the Everest of telecom debt that has now accumulated doesn’t look as though it can be repaid on time, even with the extravagant promises surrounding high-speed wireless services.
Just in Europe, the sums are staggering, with nearly $150-billion tied to the sector. Among the notable borrowers are France Telecom, which has accumulated $54-billion; British Telecom is saddled with $42-billion; Vodafone looks positively well-off with $13-billion on its books; France Telecom cellphone division Orange said to be interested in a stake in South Africa’s MTN has $5-billion.
The same infection is also in US telecom equipment companies that financed carrier purchases. These sums are both frightening and staggering. Lucent is in for $6,5-billion, Winstar must repay $1-billion as must XO Comms. There’s no reason to forget Northpoint Comms, which filed for bankruptcy in January with $250-million owing.
The leveraged companies cannot pay down these debts relying on their current or even projected cash flow which will result in their spinning off divisions and using the capital raised to keep the banks happy. Or they will sell off those divisions entirely to competitors. Of course, they could always go for the ubiquitous rights issue, but that’s insanity when your stock is in freefall. All it really achieves is to bring the inevitable acquisition date forward.
Every which way, telecom firms that have been prolific borrowers are in a very, very tight squeeze. “Unbundling” or floating companies in this market amounts to forced selling. But without debt reduction credit ratings will be downgraded creating an even more ruinous scenario as interest payments rocket.
Across the board there is evidence that telecom companies badly misread the “new economy” shift from voice to data.
It can be seen in the flayed shares of the US premier long-distance company, AT&T, which got caught in a muddled cable strategy. MCI WorldCom couldn’t replace its voice cash cow even as it gobbled up data markets across the globe. Venerable Cable & Wireless isn’t indebted, but it does look lost with a share price that has fallen 70% in a year. Vodafone is a test case for the see-we-told-you-so crowd that excoriated it for paying so much for “third generation” licences.
It’s obvious that investors are no longer buying the old story. Orange came to market in February and could raise only $48-billion against the hoped for $152-billion.
And now the International Monetary Fund is the latest on the bandwagon with a statement a few days ago that: “The recent downgrading of some of these companies … suggests some deterioration in credit quality in this sector. Furthermore, the enormous latent funding requirements to build up telecommunications networks could increase these exposures, thus heightening the risks.” No kidding.