How quickly will America's telecom companies go through bankruptcy and reemerge as low-cost providers? And what businesses will then be built on top of low-cost bandwidth? These are good and hard questions that I can't answer.
Here the Economist chronicles what is happening to America's telecom companies. I want to see what happens next...
Economist.com: IT TAKES a brave man to invest $30m in America's torched telecoms industry. But Wilbur Ross is doing it. It takes an even braver man to predict that the industry will soon revive. And who would dare to attach a date to this prediction? “It won't take more than a year,” breezes Mr Ross, a bankruptcy specialist whose shrewd investments over the years range from American steel firms to Japanese banks.
America's telecoms industry is not to every investor's taste. Scores of operators have gone bust. Several more big firms live at the mercy of their bankers. In the wholesale market—for everything except the last mile into the home or office—over-capacity continues to push down prices. The softening of demand seems without end. Capital spending could fall this year by a massive 34%, according to Morgan Stanley, an investment bank.
Telecoms-equipment makers such as Lucent now have a new “core competence”: downsizing. Even the mostly monopolistic local operators, the Baby Bells, whose retail markets were thought to offer sanctuary, are suddenly said to look exposed. The talk in Washington is that the regulators, who have only just begun to open America's local markets to competition, are now being persuaded to slam the door back shut.
It is just this sort of carnage which attracts bargain hunters such as Mr Ross. He has invested in a firm called 360networks, one of many fibre-optic wholesalers that borrowed heavily in the 1990s in the mistaken belief that Internet traffic would double every 100 days. When 360networks emerges from bankruptcy at the end of this month, it will have only $215m of debt, less than one-tenth of its burden when it went bust. The firm will also, says Mr Ross, have a completed network, customers and $100m of cash, with which it plans to buy bits of other bust wholesalers on the cheap. Another operator, Williams Communications, could emerge similarly refreshed from bankruptcy next month.
These new, low-cost producers will heap still more pressure on the remaining debt-laden wholesalers, notably Qwest, Level 3 Communications, Sprint and Broadwing...
IT TAKES a brave man to invest $30m in America's torched telecoms industry. But Wilbur Ross is doing it. It takes an even braver man to predict that the industry will soon revive. And who would dare to attach a date to this prediction? “It won't take more than a year,” breezes Mr Ross, a bankruptcy specialist whose shrewd investments over the years range from American steel firms to Japanese banks.
America's telecoms industry is not to every investor's taste. Scores of operators have gone bust. Several more big firms live at the mercy of their bankers. In the wholesale market—for everything except the last mile into the home or office—over-capacity continues to push down prices. The softening of demand seems without end. Capital spending could fall this year by a massive 34%, according to Morgan Stanley, an investment bank.
Telecoms-equipment makers such as Lucent now have a new “core competence”: downsizing. Even the mostly monopolistic local operators, the Baby Bells, whose retail markets were thought to offer sanctuary, are suddenly said to look exposed. The talk in Washington is that the regulators, who have only just begun to open America's local markets to competition, are now being persuaded to slam the door back shut.
It is just this sort of carnage which attracts bargain hunters such as Mr Ross. He has invested in a firm called 360networks, one of many fibre-optic wholesalers that borrowed heavily in the 1990s in the mistaken belief that Internet traffic would double every 100 days. When 360networks emerges from bankruptcy at the end of this month, it will have only $215m of debt, less than one-tenth of its burden when it went bust. The firm will also, says Mr Ross, have a completed network, customers and $100m of cash, with which it plans to buy bits of other bust wholesalers on the cheap. Another operator, Williams Communications, could emerge similarly refreshed from bankruptcy next month.
These new, low-cost producers will heap still more pressure on the remaining debt-laden wholesalers, notably Qwest, Level 3 Communications, Sprint and Broadwing, which are still trying to avoid going bust in the hope that demand might miraculously revive. As 360networks and similarly once-bankrupt firms relaunch themselves, however, Mr Ross is betting that the market will not take long to find out that this hope is false. That will produce short-term pain worse even than that already afflicting telecoms—but also a much clearer sense of what a healthy, less-indebted industry might look like.
If so, what will become of WorldCom, the disgraced giant that went bust in July claiming that its (supposedly market-leading) wholesale business was still making money? As WorldCom's accounting restatements grow, this claim looks increasingly suspect. The giant of the industry, AT&T, almost killed itself in the late 1990s trying to match WorldCom's margins, which turned out to be fictitious. Now its arch-rival is in bankruptcy, AT&T plans revenge. Criminal prosecutions for WorldCom's accounting fraud will destroy any value left in its brand. WorldCom's bonds trade at prices that suggest the firm will probably have to liquidate itself.
And what of the Baby Bells, whose retail markets supposedly face a fate similar to that of the wholesalers? Here, the crisis seems to dwell mostly in the imaginations of their lobbyists. For the first time since the depressed 1930s, the Baby Bells have begun to lose home-phone lines—to competition from wireless, long-distance and cable companies. But this erosion is likely to remain gradual.
Offsetting the lost business, meanwhile, are new long-distance revenues and the Baby Bells' large stakes in the wireless industry, which competes with them. Their share prices have fallen by more than the stockmarket average this year. But that may reflect the fact that, after a brief fling with the idea that they could be growth stocks, the market has returned to the old view that these are highly regulated, low-growth monopolistic utilities.
The overall picture, then, is of an industry that continues to split down the middle. Their falling shares having stripped them of an acquisition currency, the Baby Bells will retreat to their core consumer market to fight the cable firms for a share of the household budget. That leaves the more innovative and faster-growing business market to a handful of big, less-indebted carriers that will emerge from the consolidation of the wholesale industry.
And top of the heap? AT&T, which will emerge, once its cable business is spun off at the end of this year, with the right-looking balance sheet, an unmatchable list of blue-chip customers and more data traffic than its two biggest rivals combined. Unlike its competitors, the rate of growth in AT&T's data traffic continues to increase, as customers sensibly opt for a strong carrier over weaker ones. Mr Ross plans to follow a similar strategy.
Hal Varian would be a fine person to ask about a possible transition for the fiber optic industry.
If I understand the transition for the railroads, company reorganization allows new ownership to lower prices considerably because there is less debt for a "new" company. Lower prices allow for others to use the fiber optic lines at less cost, so new internet businesses should crop up.
Posted by: on October 14, 2002 12:13 PMLet us suppose that things do work out---each successive domino falls into bakruptcy and emerges with the bankers and bond holders reasonably OK and the shareholders losing everything. Fine.
Now let's ask the question, what happens the NEXT time someone wants to install massive infrastructure that essentially provides a commodity service? (As an aside, what might such a service be? Perhaps a completely automated package delivery system using standardized (but smaller) containers and packet-switching ideas from the internet.)
We have established here (as if any proof were necessary), just how correct Marx was when he spoke of how selling commodities was bound to end in tears for everyone. Surely we have also established that shareholder financing for the next round of infrastructure (whatever that may be) is quite infeasible? Or is the hope that new idiots with no sense of history are born each generation?
Posted by: Maynard Handley on October 14, 2002 12:49 PMwhat does the codeterminacy of the investment and financing decision (implicit in the comment that new heavily equity financed producers can put pressure on the heavily debt financed producers) tell us about the state of the capital markets today? if there are profitable investment opportunities available, why does it matter how the company is financed?
i'm surprised that no one could see that given the huge costs of disruption possible (a.k.a. financial distress costs), these companies needed heavy equity financing.. and that debt would be a huge liability in the bad state of the world.. Why did the capital markets not foresee this (not inevitable, but still highly likely) outcome?
Any similarity to the emerging markets financing decision is not entirely accidental.. why is the IMF spending time on a sovereign debt restructuring mechanism when the answer (as Ken Rogoff knows for at least fifteen years) is greater equity as a component of capital flows?
Posted by: on October 14, 2002 03:03 PMTwo interesting results:
1) Telecom companies that did not "misplace" or simply waste all their money are being punished by the favors the bankruptcy system shows to those that did.
2) The "market" and the state have allowed those who financed all these deals to escape any negative consequences.
I have a question related to Maynard's, I believe (perhaps redundant) - will massive telecom bankruptcy wave simply push the supplier tier in to a similar wave of bankruptcies?
Posted by: Barry on October 15, 2002 09:45 AMAlcatel and Ericcson will not be allowed to fail by the respective governments. Nortel "may" be helped by Canada. What then about Lucent? I expect Lucent might save itself by diluting stock or might even reorganize debt. Since Lucent however is the leading telecom supplier, I expect it to continue.
Posted by: on October 15, 2002 10:20 AMIs Citizen K living in some alternate universe in which "those who financed all these deals to escape any negative consequences"? Have you checked the stock quotes of Lucent, Nortel, AT&T hell, Bell South lately? What about that JPMorgan earnings warning, largely connected to bad debt expense from telecom loans? What about the public bondholders of numerous telecom firms trading for 20 or 30 cents on the dollar?
Posted by: JTreves on October 15, 2002 12:11 PMIs JTreves living in some alternate universe where he thinks that the high ranking executives and the CEO's who were running these companies during their heyday didn't make out very well at that time due to stock options? The companies and their employees may be suffering, but those who made the bad decisions are by and large doing very well.
It's known as moral hazard. Heads I win, tails you lose. Or worse, either way I win, and some other sucker pays the bill.
As an aside, I expect the Canadian government will help Nortel if push comes to shove. It would simply be too painful to let it go down. It would also devestate Ottawa (which has already taken a number of gut punches and a nad twist from the Nortel problems.)
Posted by: Ian Welsh on October 15, 2002 10:14 PMI tend to think of those who "financed" this telecom boom as the equity and deb purchasers. Not those who by happened to have been in charge of those companys. These holders are hurting.
Don't learned economists tell us that rational choice on the part of individuals is what drives the market? Clearly, it is rational to churn huge financing deals of OPM in order to maximize one's own individual earning. And, clearly, the various investors don't really object or money would be flowing to alternatives to JPM with more responsive management. And if you look at where investment capital is flowing today, you will see that the market rewards ineptitude and even outright criminality on the part of some people. For example, the former managment of the Columbia HMO groups are now running the Ardent group to the applause of stock pickers and investment bankers.
The summary lesson is that investment flows to maximize the income of managers of investment funds, which has apparently nothing to do with the underlying strength of the business. And the legal and market system are designed to allow certain sectors to escape most of the consequences of poor business operation. So JPM and Citi pour money into WorldCom with apparently no diligence whatsoever, and pain falls on the workers at the various companies swallowed by WorldCom, the suppliers to those companies, the competitors who have to put up with debt and then bankruptcy financed competition, and the defrauded stockholders.
Yet, our economist friends keep complaining that the eternal verities of their field, which predict exactly the opposite of what happens in mere reality, are not taken seriously.
Welsh -- those aren't the providers of capital, as William Utley wrote. You're just changing the subject to avoid thinking about your misconceptions.
"The summary lesson is that investment flows to maximize the income of managers of investment funds" -- it's by nature a very competitive and fragmented business, running investment funds, and includes a lot of people who are betting against rises in security prices. From your last post, citizen k, I just have to doubt that you know what you're talking about. Let's just take one example: JP Morgan Chase, which is suffering in multiple ways from unwise lending in the telecom/cable industry. The stock has been crushed in the last year, punishing credit officers there. So they have suffered for their decisions. As for your larger point, I'll let an economist answer that, but pricing securities involves attempting to divine the future and expectations are affected by emotions.
Posted by: JTreves on October 16, 2002 10:00 AMNormally one would think that "providers of capital" would be the people who made the decisions and profited from the transaction, but I suppose you could define it as "people whos assets were transferred". e.g. as in "the 401K holders of companies purchased by Enron and worldom were providers of capital".
As for JPM, for an extended period of time, JPM arranged for vast sums of money to go to WorldCom. The bonus payouts are done, the fees have been collected and distributed, the suffering of the current loan officers has little effect. And consider the killer rates JPM is getting on the loans to Chapter 11 customers. JPM bad loans is up a not enormous $3B from last year - its stock is mostly tanking on fears about its derivative position as far as I can tell.
Finally, "pricing securities" is not at issue here. What is at issue is that JPM had significant involvement with Worldcom and somehow was unable to notice that $9B had gone astray, the business fundamentals were not solid, and revenue was being inflated by dubious accounting. The issue is the basis of capital allocation - and it certainly appears as if allocation is driven by a crony or class system capitalism.
Note that if money goes to A, it does not go to B. So while JPM sent money to Ebbers and Enron and similar, people who wanted to build robot factories in Brooklyn or start maid service operations where workers got a living wage or so on, did not get money poured on them. What we see here is that investment decisions are made with a diligence, an understanding of firm operation, and an attention to the bottom line shown previously by GOSPLAN.
Posted by: citizen k on October 16, 2002 01:02 PMCitizen K: OK, good answer. I retract my comment about your knowledge of the subject matter and apologize.
I do think securities pricing is the key to the problem. And the pricing in the "Boom Years" was established by completely-erroneous judgements based on bad data (the WorldCom EBITDA manipulation) and influenced by the glamour of now-discredited executives (like Ebbers) and the exuberance of a bull market. Just take an alternative scenario in which WorldCom's EBITDA margins were not believed (because they were so much higher than the competition's) and it was not given so much debt financing and its stock price never rose to very high levels. Would that necessarily indicate a systemic problem if the firm went bust eventually? No -- it's the magnitude of the error that's the problem. So, basically, I think we agree that there was some element of cronyism in the whole situation, although maybe "cronyism" is the wrong concept. How about "groupthink"?
But the key to correcting the situation is that those responsible for making the mistakes pay. Well, it sure looks like they are to my eyes. So the system is correcting itself.
Posted by: JTreves on October 17, 2002 07:01 AMJTreves.
Groupthink or cronyism or both, but
1)Why did so many ill informed and undiligent people ever get to be in charge of so much money?
2) What's the market effect of their failures?
My observation from the edge of the market is that the people who make investment decisions generally don't know a whole lot about their markets, the products being sold or made or used by the companies they invest in. They have no basis for being able to tell an Ebbers from a real-visionary or know when a Skilling is going from being sharp to just sounding as if he knows what he is talking about. I don't necessarily think these are easy things to know, but surely when a couple of billion is at stake, a top investment bank could afford a team of smart people who could make the call well most of the time. Instead, they seem to rely on groupthink and "gut feelings" about character and such - which sounds like a cover for cronyism. And this leads to the question of "what now"?
You might expect that investors like TIAA/Cref or Berkshire Hathaway would be being studied intensively, and the major investment banks would be, like the CIA and FBI after their massive failure, engaged in a complete re-evaluation of their process - oops! Well, you see what I mean. The whole thing has the appearance, as does much of the American system, of being closed loop groups of people who are able to avoid dangerous innovations by controlling their own evaluations.
The smart thing, in theory, about markets and
democracy, is that being right gets rewards and being wrong gets you dumped from positions of authority. I don't see that happening here.
Good points. But I think you're probably underestimating the amount of reevaluation that is occurring. It's hard to know looking at it from the outside because information about it is not publicly available. The asset management business is in turmoil these days and there are a lot of people losing jobs and a lot more making a lot less money.
In general, making assessments about large firms in complicated industries is a tough job, as you point out, and there are often only a few people in an industry who know enough to make intelligent and fully-informed judgements. Instead, markets rely on the diffusion of signals and, judging from stock prices, often have an almost magical way of conveying information that is not yet public or fully-understood. For example, your well-taken point about how JPMorgan's recent stock plunge is related to its derivatives exposure is well-taken and I believe correct but keep in mind that the stock has been trading below its peers for a couple of years now, during a period when the troubles of the telecom industry were becoming apparent, something which we can attribute to information about its lending practices.
Maybe I'm wrong about this but I think part of your discomfort is caused by the feeling that those who made big investment mistakes aren't being punished severely enough. That may be true but you can point to cases where these former business leader's lives are being ruined (the Enron crooks, Kozlowski, the Adelphia crooks as well as the less-malign WorldCom execs) and you can count on a lot of other people making less money and losing their jobs.
Posted by: JTreves on October 18, 2002 07:08 AMPunishment is a minor issue - although it is infuriating that lemon socialism has now been supplemented with decrease in civil liberties at the bottom of the ladder, while the Milliken's and their successors get to keep the loot after, at worst, a couple of years in Club Fed.
What I'm concerned with here is capital allocation. It's obvious why capital allocation via some GOSPLAN or a state Kleptocracy is a bad thing. But here we have an extreme case of Wall Street allocating for the construction of vast palaces in Mississippi and huge leveraged corporate empires that have no hope of a real business. The telecom stuff is an example, not an exception. Consider Clear Channel or AOL/Times-Warner or AT&T's absurd cable acquisition spree or the revival of the parts of Columbia/HCF with apparently limitless money to spend.
The really interesting question is how many actually workable business plans have failed to be capitalized while all this dumb investing takes place. Are there companies based on simpler, cheaper, faster, telecom technologies e.g. wireless, that did not get the nod or got outcompeted by companies that lived on debt? Are there thousands of small businesses in Harlem and Central LA that did not find capital, because it was certainly easier and more personally lucrative for the self-selected white MBAs of Wall Street to structure mega deals with ClearChannel? Did rebuilding the port of New York or making a new kind of engine seem too dull to people entranced with meta-finance? And so on.