The Tidal Wave Bearing Down on Telecom


By Alex Salkever In May 1998, Global Crossing (GBLXQ) went live with its first transoceanic fiber-optic cable, Atlantic Crossing 1. The cable formed an undersea loop of nearly 9,000 miles, stretching from Long Island across Britain, the Netherlands, and Germany before snaking back to the U.S. Its capacity of 40 gigabytes per second was a huge improvement over competing undersea cables at the time.

Suddenly, dreams of a world connected by a fast Internet connection became boundless. And most startling of all, Global Crossing had built this network on its own. In the past, telecoms had deemed such a solo venture too risky, choosing instead to split the costs of laying these "backbone" cables.

Soon every telecom with global aspirations launched its own subsea expedition, trying to copy Global Crossing's daring business model. Demand for bandwidth could only rise, they figured, and they would wire the world. But on Jan. 28, the gold rush that Global Crossing founder Gary Winnick spawned may have come crashing to an end. Staggering under $12.5 billion in debt, the pioneering fiber-optic giant declared bankruptcy. And suddenly the question is: Who's next?

HEAVY SHADOW. Just a few weeks ago, most telecom giants in the global fiber-optic business acknowledged it would be a disappointing year, as the sluggish economy would continue to depress revenues. But execs and analysts expected the picture to get brighter again soon enough. Who would bet against demand growing for global networking in the 21st century? Build it, and people and corporate customers would come.

But the Enron debacle is casting a heavy shadow on all companies with big debt,

and that darkness fell squarely on Global Crossing when its former chief financial officer alleged accounting tricks that, while legal, could have artificially pumped up revenues. That, in turn, led to a marketwide revulsion for anything telecom, focused particularly on the upstart backbone carriers most similar to Global Crossing, such as Level 3 (LVLT), Williams Communications (WCG), and Broadwing (BRW) (see BW Online, "The Telecom Monster: Not Dead Yet?"). Broadwing announced a large asset sale on Feb. 5, most likely as an effort to shoreup its balance sheet.

In addition to the upstarts, even old war horses like AT&T (T) and WorldCom (WCOM) appear to be struggling. Analysts and industry insiders now see the beginning of a long-awaited retrenchment and consolidation.

DIFFERENT LINEUP. Indeed, no one with large stakes in undersea networks appears to be safe. And a year from now, the telecom lineup could be dramatically different. "The backbone industry will scale back to four or five major players," says Kenneth Carter, deputy director of Columbia Institute for Tele-Information at Columbia University in New York City.

That means only a scant few of the dozens of upstarts that were built mainly on the construction and ownership of these vast networks in the past five years could be left intact. Established carriers such as AT&T and WorldCom that own pipes and sell telecom services directly to both businesses and consumers could be more insulated. But they'll likewise face bigger risks. A bevy of foreign telecoms, such as France Telecom, also have placed huge undersea bets. They, too, could face significant losses going forward, enough to rock the international telecom market.

What happened? The numbers in the subsea cable business paint a stark picture. From 1997 to 2001, trans-Atlantic cable capacity increased more than 20-fold, according to TeleGeography, a telecom consultancy. Trans-Pacific capacity soared 40-fold. As so many lines were laid, demand for the services became diluted. Prices for wholesale bandwidth on land and sea plunged apace, falling between 50% and 70% a year.

DIVING AND DIGGING. Before Global Crossing launched in 1998, the standard lifetime contract for 155 megabytes of capacity went for $20 million. Global Crossing dropped that immediately to $8 million. By the end of 2001, that same deal drew only $350,000. Long-term contracts no longer hold their allure for customers, who now seek out more flexible one-year or two-year leases.

Still, other players kept plunging under the water, each believing there would be a huge boom in demand for telecom and data-communications services. In addition to subsea cables, they dug hundreds of thousands of miles of trenches on land in anticipation of extending their reach around the globe These players included the one-time darlings of the dot-com era, such as Level 3, Frontier, and Qwest (Q).

As their miscalculations became apparent, many of these companies scrambled to find new markets in providing big circuits to global businesses. Trouble was, AT&T and WorldCom pretty much own that business, with Sprint a competitive No. 3. That left little room for upstarts to nab lucrative multiyear deals that involve setting up big switching boxes on a corporation's premises.

GASPING FOR CASH. The result has been higher cost of sales. "Execution goes back into sales and marketing, and how you penetrate into the enterprise market. It becomes very hard for the fourth and fifth players to penetrate that market," says Muayyad Al-Chalabi, a director at telecom consultancy RHK. "You almost go back to the Rule of Three -- that any market can really only support three players."

All told, it left many long-distance carriers gasping for cash to pay their debt obligations. "Some of the more highly leveraged companies are really struggling. They don't have the cash flow to make their payments," says James Glen, a telecom economist with Economy.com

Meanwhile, Sprint, WorldCom, and AT&T went on telecom buying sprees that have left them more reliant on their big-business sales -- and deeper in debt. AT&T is still recovering from money-losing joint ventures such as the Concert alliance with British Telecom and CEO Michael Armstrong's multibillion dollar acquisitions of cable networks, which he's now divesting. WorldCom shares now ride at seven-year lows as spooked investors speculate that multimillion-dollar company loans to CEO Bernie Ebbers might presage bigger accounting difficulties. The company has denied any improprieties.

ERODING FRANCHISES. Worse, Baby Bells such as Verizon (VZ) and SBC (SBC) continue to eat away at consumer long-distance monopoly of AT&T, Sprint, and WorldCom. That's on top of the woes the big three already face in operating backbone undersea and land-based networks, which they resell to other operators in some places. While Sprint, WorldCom, and AT&T don't face the type of imminent cash crunch as Global Crossing does, a consolidation among even the major long-distance providers is now a possibility.

The Baby Bells face fallout, too. In their move to quickly consolidate, they also took on big debt to buy each other. But their local-calling franchises could quickly erode as the same high-speed data pipes that deliver the Internet will soon provide high-quality local-phone service over cable and digital-subscriber-line modems.

Now, many banks that lent to telecoms for acquisitions and building binges could be left holding the bag. While a government bailout is unlikely, these fiber networks won't go dark. Like office buildings, the big costs in laying out telecom networks come up front, so once these outfits are bought at a significant discount or go bankrupt to clear their debt, they become more attractive assets. "It's not like these companies will disappear. They do have assets that will be worth money," says Economy.com's Glen.

"FIGHTING SHOT." That's the bet Asian investors Hutchinson Whampoa and Singapore Technologies Telemedia making with their $750 million plan to acquire a 79% stake in Global Crossing. Aside from trying to rescue huge amounts of Asia's backbone data- and voice-transmission capacity, they think that debt-free, they might be able to make a go of it. "Hutchinson has been a very smart player internationally. I think they have a fighting shot," says Carter of Columbia Institute for Tele-Information.

Here's the final irony: A rescue of Global Crossing may further hasten the demise of others. Analysts say the reconstituted entity, free of debt, could roil the market again by coming in below the prices of other long-haul backbone providers. That could depress prices even more.

The only upward pressure on pricing on the horizon seems to be low-double digit rises in international call volumes spurred by deregulation and, more important, the growth of the Internet. Telegeography's Stephan Beckert says Internet backbone providers bought 175% more fiber capacity in 2001. "That's a sharp increase, given it came after the bubble burst," he adds.

SPREADING PAIN. It'll probably be a long time before demand catches up with network supply again, however. And the pain has begun. Bond-ratings agency Fitch recently downgraded Sprint's issues. On Feb. 5, Williams Communications announced that its former parent company, Williams Cos. (WMB), was selling off a Midwest petroleum pipeline -- a move analysts say looks like an effort to pay down the more than $2 billion in debt accrued by the telecom arm, for which Williams Cos. has exposure.

Qwest recently announced that it, too, would seek asset sales to pay down debt. And bond values for WorldCom have declined sharply in recent weeks as Wall Street traders further discounted the company's prospect. That could be just a taste of what's to come. For the foreseeable future, telecom may be in for a shakeout that hits even the sector's biggest names. Salkever is Technology editor for BusinessWeek Online


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