In Too Deep - Company Operations

With too many companies laying too much fiber, the telecom industry is due for a shakeout. Someone's going to get buried six feet under.

ALEX MANDL WAS TELECOM'S GOLDEN boy. While president at AT&T, he was being groomed to become the company's next CEO. But in 1996, he shocked the industry by throwing his security away to join Teligent, a startup telecom provider.

There was little reason to notice William Schrader, on the other hand; He started in obscurity founding PSINet, one of the first Internet service providers in the United States. He spent the better part of the 1990s building his company - through canny deal-making and risky financing - into a colossal international telecom firm. [See sidebar, page 34.]

One day last week both men landed in the same place: out of a job. With both Teligent and PSINet teetering on the brink of bankruptcy, the two chief executives found themselves deserted by investors and unable to keep their companies afloat.

They aren't alone. The telecommunications industry is suffering through a rash of bankruptcies, with scores of companies in a race against bond default and insolvency. Some will lose - but in a perverse sense, that may be the only way to get the telecommunications industry healthy again. The financial markets have decided the sector has too many companies laying too much fiber and competing for too few customers. Like an overgrown garden, it needs a good pruning.

First on the clip list: telecommunications carriers like Teligent that offer phone and networking services to businesses and consumers. Next to go will be companies that lay fiber-optic cables across the continent and under the seas.

It's unlikely any of these will be bought before they go bankrupt. And unlike other struggling industries in the past, there is no sign of consolidation for carriers. Companies are left to die, and their customers are tossed to the wind. This fact became most clear when NorthPoint, a DSL provider, went bankrupt in March only to see AT&T buy its assets for $135 million, a fraction of the money poured into the company over the past few years.

EVER SINCE THE TELECOMMUNICAtions Act of 1996 deregulated the U.S. telecom industry, a multitude of carriers have spent billions of dollars building their own networks to compete for growing demand for bigger, faster bandwidth. The effort tapped thousands of investors to the tune of $715 billion last year alone.

That well has suddenly gone dry: Only $80 billion is projected to be invested for all of 2001, according to Credit Suisse First Boston. The result: The whole industry, from AT&T and WorldCom down to the smallest carriers, is in a squeeze. While those two titans are not on the bankruptcy watch list, hundreds of other firms are.

"The pendulum swings both ways when it comes to the financial markets," says Chuck McMinn, chairman at Covad, a DSL provider. "We saw tremendous enthusiasm in the telecom space in 1999 and 2000, and now we're seeing tremendous disinterest in 2001."

Disinterest indeed. Investors have simply decided not to bet on telecommunications companies anymore. In December, Teligent secured a $250 million line of credit from Rose Glen Capital - enough to pull the company through a cash crisis. But Teligent never saw a penny because it couldn't come to terms with Rose Glen, which demanded certain price and volume criteria for the company's stock.

That's all a vulnerable telecom needs to take on the whiff of impending doom. "It becomes a self-fulfilling prophecy," says John Page, senior telecom analyst with Moody's. "Once there's any doubt a company can access the capital markets, that effectively closes off any access to those capital markets they might have had."

Ron Vidal, co-founder and senior vice president at fiber-optic network provider Level 3 Communications, says many of these companies didn't recognize how fickle the investment community could be and failed to fill up the tank when they had the opportunity. "Now they can't raise any more cash," he notes. "You're seeing the results every day in the financial news."

Fickle or not, it's hard to blame investors for turning gun-shy in the face of a shakeout. There are 300 competitive local-exchange carriers, 14 national backbone providers and countless long-distance players, including AT&T and WorldCom. Not only are there too many companies, but too many have taken on enormous debt to compete in this crowded world - an estimated $213 billion in junk bonds from 1996 to 2000.

Upstarts such as 360 Networks, Aerie Networks and Velocita are particularly vulnerable, since they've still got their picks in the ground, building national and global Internet networks even as it becomes clear there's already too much fiber.

"Not only is there a real potential for oversupply if these predictions hold true, but with prices dropping the way they are, it'll be seriously difficult for these companies to make any money at all," says Hilary Mine, an analyst with Probe Research. She says peak Internet traffic carried by telecom companies grew at a healthy 300 percent last year, but companies are growing revenue at only 30 percent, a potentially deflationary situation.

For customers, the oversupply means lower prices. The average charge long-distance carriers levied for routing calls, for instance, fell from 23 cents a minute in 1998 to about 7 cents a minute at the end of 2000. That has made it impossible for long-distance phone companies to build their businesses.

In the Internet networking game, prices are dropping even faster, and that's before anyone has really figured out how to make money off these new networks. Consider this: Level 3 already figures the price of bandwidth will drop by 25 percent a year.

BUT IF THERE'S A SHAKEOUT COMING, people would rather be shaken up than out. Covad, for example, has been struggling, laying off hundreds as part of a restructuring. The firm's "No. 1 focus is profitability," says Covad's McMinn. "We've adjusted the dials on our business to settings that focused on building the network and signing subscribers to getting on the quickest path to profitability and slowing our growth rate. They forget it takes time. They're looking for instantaneous change, and it won't be there."

The news, of course, is not all bad. The overall market for telecommunications services is growing at 10 percent a year, and traffic is increasing at a vigorous pace. It may be years before the industry rights itself, but those who survive have growth to look forward to.

"I guess this mess was somewhat inevitable -- I just wish we'd have had a softer takeoff and landing," says Armando Geday, CEO of telecommunications chipmaker Globespan. "But I do know the demand is there, and if you can weather this downtime, the business is real and growing. Healthy companies will survive."

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COPYRIGHT 2001 Standard Media International
COPYRIGHT 2001 Gale Group