Just when we thought that the telecom industry was calming down after two years of economic depression, bankruptcies and criminal investigations, a new storm is brewing. What is capturing many executives´ attention now is the industry structure post WorldCom bankruptcy. In short, when WorldCom emerges from bankruptcy as planned in March of 2003, what will it look like, what is its debt and what does it all mean to the telecom industry? Beyond the fact that WorldCom will not be lead by John Sidgemore, there is little information to extrapolate the structure WorldCom will have in March of ?¬¢‚Äö?ᬮ?Ä??03. There has been no discussion of a WorldCom break-up. If Global Crossing is any indication, WorldCom will emerge from bankruptcy pretty much intact, offering its wide suite of telecom services including Internet access, data networking, hosting, voice services, etc. So what´s the problem?

The problem is that AT&T, Sprint and others have a heavy debt burden, while WorldCom may not. Debt is what got the industry into its current malaise and still haunts it. In fact, Qwest recently was forced to sell shares of its own stock to make debt payments. According to Salomon Smith Barney, AT&T is straddled with $37.3B and $5.8B in long and short term debt, respectively. Sprint has borrowed $20.3B in long-term debt. It recently refinanced its short-term debt into long-term and issued some $5B of debt in March to pay down outstanding commercial paper. When you have an industry where two of the top three players have to service tens of billions of dollars in debt and the third player does not, the third player gains a major strategic competitive advantage. What´s concerning to AT&T, Sprint, Qwest and many others is that this strategic advantage may very well go to WorldCom. In short, a competitive telecommunications industry will not be realized if WorldCom is the only carrier with little debt to service - it just won´t work.

Over the last two months, WorldCom´s competitors have been fairly pleased with the current state of affairs. WorldCom´s competitors are having a field day, plotting and winning share of its large business customers. But that party may be short-lived. A capital restructured WorldCom may be able to cut pricing well below its competitors to buy back share it´s losing now. Not having to make huge debt payments, it would be able to invest in new plant and equipment, launching new services and marketing plans that AT&T and Sprint cannot afford. In short, WorldCom may be much stronger than AT&T and Sprint when it reemerges in March of 2003.

So what are AT&T, Sprint and other carriers to do about this? Four options:

1. Follow WorldCom into Chapter 11 and restructure their capital commitments
2. Tough it out
3. Spin-off various divisions and push debt into those groups
4. Seek the shutting down of WorldCom.

AT&T & Sprint Follow WorldCom into Chapter 11

For AT&T and Sprint to follow WorldCom into bankruptcy, they would have to pass a test of insolvency, according to a New York bankruptcy attorney. If the new re-emerged, debt free WorldCom cuts prices deep enough and long enough to win back share, they may just help AT&T and Sprint to pass that insolvency test. By AT&T, Sprint and potentially Qwest filing for Chapter 11, it would allow them all to compete on a more even playing field after the painful process of bankruptcy cleanses their debt.

Toughing it Out

Toughing it out will be just that: tough. These carriers may be able to refinance their debt into terms that avoid Chapter 11. Also, being acquired, which many view is a viable option for AT&T, could be part of the ?¬¢‚Äö?ᬮ??¨tough it out?¬¢‚Äö?ᬮ¬¨?? mix. While Verizon, Bell South and SBC are healthy service providers today, its not clear if they can stay that way. The increased use of wireless minutes is shifting revenue away from wire line to wireless, which is making these ILECs sick. Many are seeing real line loss due to the increased use of wireless phones. What may make the ILECs very ill is the potential impact of public Wi-Fi hot spots, coupled with
wireless cell service further eroding wire line growth, usage and, thus, revenue.

Spin-offs

If toughing it out doesn´t work, then spinning off divisions may be an option, allowing the carriers to move debt to those divisions that spent it over the 90s. A selling and buying spree may be in the cards for telecom, moving the industry closer and closer to its post 1984 break-up of AT&T, with four large service providers standing.

Shutting WorldCom Down

Mr. Jim Cramer, co-founder of TheStreet.com, radio and television commentator, author, and for years one of Wall Street’s premier money managers, writes about the fourth option, stating, ?¬¢‚Äö?ᬮ??¨The Justice Department and the FCC should shut down WorldCom. Now. Just make it cease to exist. Give it 30 days to wind down. If they don’t, they are just writing off the whole darned industry, which would be a grave and horrid mistake for capitalism and for the country, because a debt-free WorldCom would most
certainly destroy all of the remaining players.?¬¢‚Äö?ᬮ¬¨??
(http://www.thestreet.com/p/rmoney/jamesjcramer/10043154.html)

While it´s too early to predict which one of these scenarios will play out, AT&T, Sprint and Qwest bankruptcies may very well be the event which sends Lucent and Nortel following in their footsteps. It´s unclear how much of AT&T and Sprint´s debt is owned by Lucent, Nortel and Cisco, but if forced to subordinate its position to the claims of other creditors during bankruptcy hearings, then this would clearly be another blow to the beleaguered equipment suppliers. Both Lucent and Nortel have not stopped delivering downward guidance and cutting expenses to cope with the falloff in telecom spending. Lucent, in particular, has been forced to
push out its return to profitability forecast numerous times. As I write this report, Lucent is trading at 98 cents a share, while Nortel is trading at 70 cents. Many believe that bankruptcy is already factored into both companies share prices.

While Cisco is far from a financial crisis, its major concern is its stock price. Cisco could and most likely will experience a pull back in its stock price if the IXC market restructures, even though only 20% of its revenue is derived from the service provider industry. Cisco is still priced as a high growth and high gross margin concern. While the latter is still true, the former is questionable - and if AT&T and Sprint follow WorldCom into Chapter 11, that question may be answered. But Cisco has more near
term revenue growth problems. Its backlog is shrinking from $3.4B in 2000 to $1.4B now. We all know that high growth is not part of Cisco´s financial picture these days, and the backlog pullback is a strong leading indictor that it is having problems realizing the ?¬¢‚Äö?ᬮ??¨10% above the market revenue?¬¢‚Äö?ᬮ¬¨?? growth projections it has provided to the industry. However, thanks to its Enterprise business, Cisco will weather this storm far better than any of its major equipment supplier contenders - but it won´t go unscathed.

The entire industry may be forced to restructure its capital commitments in 2003, thanks to WorldCom´s Chapter 11 filing in the summer of ?¬¢‚Äö?ᬮ?Ä??02 and its current acknowledgement of $9 billion worth of fraud. Ironically, it was MCI nearly two decades ago that forced an industry wide restructuring with the dismantling of the bell system, and it looks like it´s doing it again.

The service provider crisis is not just contained to the US. European carriers are faced with the same debt issue, as are US carriers. Nearly all European telecom service providers spent tens of billions to purchase G3 wireless licenses while the 3G market has not materialized. Yes it´s a bad scenario, but with revenues way off and dept servicing obligations way up, it´s not clear if it can be avoided. Perhaps the fear of this scenario is so great that the large service providers may choose to disaggregate their services by spinning off various divisions to concentrate on profitable and promising services such as bundled packages for
consumers, enterprise and wireless markets. Or, they may get very vocal and stress that WorldCom needs to be broken apart.
In any case, the service provider world is in a highly uncertain state. With a loss of $2T+ worth of value, over 60 bankruptcies and 500,000+ jobs lost, the carriers are being hollowed out. So what can CIOs do to protect their companies? First and foremost, service quality will almost certainly suffer during these turbulent times, so diversification of service providers is essential. CIOs should instruct their network architects to audit their enterprise networks to ascertain which service providers they are using for
which services, and how much they are spending with each. Try to split the pie as evenly across all service providers as possible. It´s time to reevaluate those service provider contracts that provide discounts for longevity and volume, since flexibility and carrier diversity should be design goal number one.

Along with carrier diversity, it´s time to take control of communications back from the service providers. During the late 90s, there was a shift toward using carrier services for most enterprise communication needs. The balance of build versus lease for enterprise communications should tilt back toward build, and tilt steeply. Two parts of the enterprise network that should change quickly are voice and private wide area data networking. In the voice area, economic efficiency and increased productivity through collaborative communication applications has been proven with ?¬¢‚Äö?ᬮ??¨open?¬¢‚Äö?ᬮ¬¨?? IP Telephony solutions. We are at the stage now where IP Telephony solutions can be extended over wide area IP networks reducing toll cost and arbitraging private line tariffs. For a full
review of today´s IP Telephony suppliers see The IP Telephony Market & Vendor Report at http://www.lippis.com/reports.htm

Also, while there is a shift to replace private wide area backbone networks to public multi-homed Internet services, CIOs should explore accelerating this shift with the use of route control products. Private networks are expensive in both capital equipment and operational spend, static in their configuration, and not flexible enough to change if you are having carrier problems. Chances are over the next year and a half you will experience a higher frequency of carrier problems. For intranet and extranet traffic, using Route Control to move packets between carriers based upon performance, price, delay, jitter, etc is an excellent insurance policy for an unstable carrier environment. (See The Lippis Report #002: Welcome Route Control to The Industry http://www.lippis.com/backissues.htm)

Private network structures can be reconfigured with route control into multi-homed public ISP connections to a variety of service providers delivering control, diversity, lower cost of ownership and piece of mind while the service provider industry changes.
Route control brings predictable performance to ISP links, allowing enterprises to move IP Telephony, VPN and other traffic over this infrastructure and between company sites. Can any good come out of this restructuring in the telecom industry? Well
Global Crossing has secured new cash and reduced its debt, and it will reemerge in early 2003 stronger than when it went in.

Yipes!

Communications just re-emerged with new cash and a restructuring of its debt and fiber lease terms, again stronger than when it voluntarily went into bankruptcy. There is also new money entering the industry; Warren Buffett has infused Level 3 with cash, saving them from potential bankruptcy. In short, its going to get worse before it gets better, but there is light at the end of the tunnel in 2004. After the telecom industry goes through this capital restructuring and simultaneous executive management change out, chances are it will re-emerge stronger and better than when it went in. Unfortunately, bondholders, shareholders and employees may be stuck to pay for the spending binge the industry went on in the late 90s.

The main message to CIOs is this: don´t run and hide; you need to be aware of these potential events and plan. A big part of that plan is to take control of your communications infrastructure and start thinking about building services rather than leasing them from service providers. IP Telephony and Route Control are two inter-related technologies of the new enterprise communication infrastructure that can deliver control, reduce cost and increase diversity during very unpredictable times. Interestingly enough, both have been proven to pay back in ROI terms within 12 to 18 months.

Posted 2 September 2002 at 6:48 pm under Lippis Report. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.