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TELECOM REPORT
Bottomless pit threatens future
Commentary: Things can't get any worse - but they do
By Jeffry Bartash, CBS.MarketWatch.com
Last Update: 4:59 AM ET Sept. 21, 2002
WASHINGTON (CBS.MW) -- Two years into an industry free-fall, beleaguered
telecommunications executives are desperate just to hear a thud.
That's how bad things are. With no end in sight to the industry's worst-ever
slump, companies are anxious for something, anything, to latch onto. Finding
the elusive bottom would put them on sturdier ground and at least allow them to
start thinking about the future again.
Instead, the ground continues to shift below their feet. Companies continue to
slash and burn. That's put tens of thousands out of work and threatens to
hamper innovative research into new technologies.
In the past week alone, bellwethers such as Ciena (CIEN: news, chart, profile),
Alcatel (ALA: news, chart, profile) and Lucent Technologies have unveiled fresh
job cuts. More industry layoffs are almost certain to come.
"The bar keeps moving lower -- and we keep having to squeeze underneath it,"
said Lucent (LU: news, chart, profile) spokesman Bill Price. He might as well
be speaking for the whole industry.
Crash and burn
By now, the telecom industry's problems are well known. Lured by looser
government regulations and the promise of the Internet, hundreds of new
companies jumped into the business in the late 1990s. Many expanded rapidly,
aided by generous Wall Street funding.
When the U.S. boom ended, the industry found itself awash in too much
competition. Companies slashed prices, but that drove down sales and profits
and ignited a rash of bankruptcies.
The fear now is that some of the industry's biggest players are on the verge of
toppling, including WorldCom, Qwest Communications (Q: news, chart, profile),
Nortel Networks and Lucent. Some say a worst-case scenario could devastate the
industry and set back its recovery for years.
If WorldCom and Global Crossing emerge from bankruptcy protection largely debt
free, for instance, they could cut prices to attract customers. That would put
more financial stress on other big carriers that are carrying heavy debts.
"The consequences have been severe, and the damage isn't confined to the
companies now marching over the cliff of bankruptcy," asserted Verizon (VZ:
news, chart, profile) Chief Executive Ivan Seidenberg. He said companies like a
newly recapitalized WorldCom could "fuel an irrational price structure that
will drain more money from the telecom sector."
Barely hanging on
Still, big local-phone companies like Verizon still have the revenue and
resources to ride out the slump. The same can't necessarily be said for
equipment vendors such as Lucent and Nortel.
Both stocks have temporarily sunk below $1 a share and now trade at historic
lows. Each has cut tens of thousands of jobs, sold or spun off entire divisions
and scaled back their vaunted research and development programs.
What's worse, Lucent and Nortel rely on equipment sales to the large phone
companies, but they've been buying less and less new gear. Capital spending in
2002 could fall as much as two-third below the level of spending ($90 billion)
just two years ago.
Indeed, Lucent last week said fourth-quarter sales could fall as much as 25
percent below third-quarter levels. The extent of the shortfall even surprised
Wall Street, triggering another round of bloodletting.
Lucent executives maintain a brave face, saying they can hurdle the latest
obstacles strewn in their path.
Others are less sure. Precursor Group CEO Scott Cleland, citing high levels of
"short" stock sales, said: "Wall Street and hedge funds are betting that those
two companies will die."
His concern: that the failure of one or both will set back innovation in the
telecom industry for years. Traditionally, Lucent and Nortel have been the
primary developers of new telecom technology in North America.
Of course, smaller rivals such as Ciena (CIEN: news, chart, profile), Tellabs
(TLAB: news, chart, profile) and Juniper Networks (JNPR: news, chart, profile)
believe they can fill in the gap. Yet even if they're right, it would take
years for those companies to achieve the same kind of size and scope.
Besides, those companies aren't exactly prospering. Earlier this month, Tellabs
announced it would cut 800 jobs. On Friday, Ciena said it would cut 17 percent
of its work force.
What next?
So what's going to rejuvenate the moribund industry? Seidenberg, who's
agitating for regulatory relief, said it'll be the sale of wireless and
broadband services. Even Lucent and Nortel have a bright future if they can
concentrate on selling products into those markets, particularly at the retail
level, he said.
Yet Blair Levin, principal regulatory strategist at Legg Mason, sees a problem
with that approach. He notes that wireless and broadband offer lower profit
margins than older services such as local and long-distance voice. At the same
time, both require intensive capital investments.
To recover, he believes the industry has to marry profitable new services to
wireless phones and broadband access, much like the Bells generate robust
profits now from products like "call waiting."
"Where's the growth going to come from? That's the big question," he said.
Bret Swanson, editor of the Gilder Technology Report, also wonders where
telecom companies will get the money to invest. He argues that Wall Street has
shifted massive amounts of cash to unregulated industries from regulated ones.
One example: wi-fi networks. The unlicensed wireless protocol used to connect
high-speed users in homes and neighborhoods is the recipient of tremendous
investment and is the hottest technology in Silicon Valley, he said.
Of course, the best thing that could happen is for the U.S. economy to bounce
back strongly. When the recession hit, many consumers and companies cut back on
telecom services to save money. Surely they'll spend more if their own incomes
improve.
With rising sales and finances, the largest companies would then be able to pay
down their debts and even make acquisitions. A new wave of mergers, in turn,
would eliminate excessive competition, lift sales and profits and enable
companies to boost research.
"This really has to happen for the industry to get better," said Ciena CEO Gary
Smith.
It really does. But for now, telecom companies are still falling in a
bottomless pit.
Jeffry Bartash is a reporter for CBS.MarketWatch.com in Washington.
C 1997-2002 MarketWatch.com, Inc.
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