telecom slaughter house

Telecom Sector May Find Past Is Its Future
Giant Phone Companies Offer Stable, Well-Funded Option

By Peter S. Goodman
Washington Post Staff Writer
Monday, July 8, 2002; Page A01

About 500,000 people have lost their jobs. Dozens of companies have gone
bankrupt. As much as half a trillion dollars in investments have evaporated. An
accounting scandal threatens to bring down WorldCom Inc. and federal authorities
are investigating the books of other former highfliers.

There is another casualty of the implosion of the telecommunications industry: a
grand vision of the future. The idea was that deregulation and new technology
would spawn a golden age of competition, energizing the economy while bringing
consumers and businesses a cornucopia of exciting services and products.

Instead, many of those who just a few years ago bet big on this dream have
reluctantly reached a new conclusion: The future of consumer choice in phone
service may look an awful lot like the past.

Above a landscape littered with bankrupt start-ups, the giants continue to rule
-- Verizon Communications Inc., SBC Communications Inc. and BellSouth Corp., the
local telephone monopolies carved out of the breakup of AT&T Corp.

"The real nature of this business may be a monopoly business because it just
requires so much capital," said William J. Rouhana Jr., former chief executive
of WinStar Communications Inc., an upstart telephone and Internet company that
landed in bankruptcy in April 2001.

The economics of building networks, upgrading old wires for the high-speed
Internet and improving mobile phone services "are just so overwhelming," Rouhana
said. If investors will no longer bear the costs, then "to have more than one
competitor who controls the physical network may just not be possible."

Not long ago, the concept of too many competitors was unthinkable. The old
telephone business was being transformed into the plumbing for the Internet. The
sum of human knowledge was coursing at the speed of light through a global web
of fiber-optic cable. Huge profits had to be in there somewhere.

Investors poured large sums of money into telecommunications -- $880 billion
from 1997 to date, according to Thomson Financial in New York. But there were
not enough phone calls or e-mails to sustain the hundreds of new phone and
Internet networks. As that reality emerged in the spring of 2000, the great
unraveling began.

No one knows how much of the investment -- $326 billion in stock and bonds, plus
$554 billion in bank loans -- has been destroyed, but it is surely a huge
sum. "Half is as good a number as any," said Richard J. Peterson, chief market
strategist at Thomson Financial.

At least 63 telecommunications companies have landed in bankruptcy since 2000,
according to Bankruptcydata.com. As WorldCom, the nation's second-largest long
distance company, struggles to survive, and as authorities probe the books at
Qwest Communications International, which runs local telephone networks in 14
Western states, the most expensive failures may still be ahead.

"There's no indication that the bloodletting is starting to slacken," said John
Challenger, chief executive of Challenger, Gray & Christmas, a Chicago-based
outplacement company that has been tracking layoffs in the sector.

L. William Seidman, chairman of the FDIC in the 1980s, was one of the first to
recognize the scope of the unfolding Savings & Loan crisis, which ultimately
cost taxpayers at least $100 billion and investors six times more. He said that
in the end, the collapse of the telecom industry will be worse.

"It's probably the largest single meltdown in a defined industry I've ever
seen," Seidman said.

Spending Spree

From the mid-1990s until early 2000, the financial markets handed capital to
seemingly anyone with a telecommunications plan. The excitement bloomed from
technological advances as well as the federal government's efforts to loosen
regulation and invite new players into the markets. A dozen networks were built
to carry long-distance telephone and Internet data from city to city. Cable
companies began upgrading their wires to carry phone and high-speed Internet
links. Six national mobile phone companies were launched and dozens more were
set up to serve niche markets.

This enormous construction project cycled huge amounts of money through the
economy. Local and long-distance telephone companies spent $319 billion building
their networks from 1997 to 2001, said RHK Inc., a San Francisco research
firm. Mobile telephone companies spent more than $58 billion. The money landed
in the coffers of chip-making, software, computer and network equipment
companies.

All that spending, however, put the industry in danger. Demand was skyrocketing,
but capacity was growing even faster. Prices were dropping below the point where
anyone could make money. All the while, debts mounted: The eight largest telecom
companies collectively owed $191 billion at the end of last year, said Precursor
Group, a Washington research firm.

"Demand was poised to go up 30 [percent], 40 [percent], 50 percent per year and
prices were going down and you were going to make up in volume what you lost on
price," said Leo Hindery, a longtime telecom executive who, in mid-2000, was
interim chief executive of now-bankrupt Global Crossing Ltd., a long-distance
telephone and Internet firm. "If there was just a hiccup in that, you were going
to crushed."

Even so, Wall Street kept rewarding companies that played by the rules of the
day: Get big now. A high stock price gave companies currency to buy other
companies and also enriched executives. Gary Winnick, chief executive of Global
Crossing, sold more than $730 million worth of shares before his company went
down. Joseph P. Nacchio, Qwest's chief executive, sold $130 million worth of
stock before he resigned last month.

The relentless construction of networks would have been enough to fell much of
the industry by itself. Then people in lab coats mastered new ways of getting
even more calls and more Internet data to travel down one strand of fiber-optics
cable. The engineering was breathtaking. From an investment standpoint, it was
disastrous. There were already too many pipes. Now, the pipes were widening
exponentially. Prices for service fell through the floor.

From October 1998 to February of this year, the transmission capacity across the
Atlantic expanded by a factor of 19. Meanwhile, the price of a leased
transmission line dropped to $10,000 a year from $125,000, said Eli Noam, a
professor of finance at Columbia University Business School.

Some say much of the glut could have been absorbed had high-speed Internet
services spread faster. Only about 12 million consumers now buy "broadband"
Internet links, a fraction of the numbers widely forecast three years ago. The
way it looked then, the advent of broadband would trigger the development of
interactive, data-intensive services rich with video and music. All those
fiber-optic lines were needed to carry the service into homes. Cell phones and
hand-held computers would come alive with content beamed through the skies.

It still could happen, but such services have mostly failed to impress. Who
needs Internet video when HBO and Showtime seem to add more channels by the
minute? The prospect of looking at Web pages on tiny telephone screens has
generally not caught on. Regulatory arguments now rage about how best to spur
broadband. Meanwhile, the pipes stay empty.

From Boom to Bust -- Again

While the telecommunications wave of the late 1990s stands as a particularly
severe case of overinvestment and bust, it is hardly the first.

In the middle of the 19th century, railroad tracks looked something like the
fiber-optic cables of today. "The railroads opened up the Midwest and made it
possible to get grain to the Eastern ports so it could be exported
economically," said Richard S. Tedlow, a historian at the Harvard School of
Business.

Europe was in crisis and capital surged into America's burgeoning rail
system. By the latter years of the century, there were too many tracks -- seven
networks connecting Kansas City, Mo., and Chicago alone. By June 1894, 192
different companies were in bankruptcy. Together they controlled 40,000 miles of
track, about a quarter of the nation's total stock.

Some see in the railroads a consoling parallel. "The railroads all went broke,
but the laying of those tracks was the basis for prosperity in the second-half
of the 19th century," said Blair Levin, an analyst at Legg Mason and a former
Federal Communications Commission chief of staff. "Today, the U.S. is benefiting
from really cheap communications prices."

Savvy entrepreneurs such as J.P. Morgan crafted profitable businesses out of
choice railroad assets they bought out of bankruptcy. Some investors are now
looking for bargains among the telecommunications wreckage.

Bill Gross, who controls $260 billion of investment at Pacific Investment
Management Co., has been buying the bonds of battered companies such as AT&T and
Sprint Corp. IDT Corp., a discount long-distance telephone company, bought some
of WinStar's assets and hopes to buy the MCI residential long distance business
from WorldCom.

But even as the shakeout intensifies, formidable obstacles have prevented
consolidation and could continue to do so for years.

The stocks used by companies to buy each other during the boom now trade for
bare fractions of their former prices, so no one knows what anything is really
worth. Add to that the complexities of bankruptcy plus Wall Street's general
queasiness about bookkeeping.

Then there is the issue of antitrust law. It is unclear if regulators will take
a more lenient approach to mergers among distressed companies that once would
have brought strict scrutiny.

Even without those problems, consolidation may never happen among the failed
upstart local and long-distance companies. Their networks are so abundant as to
be effectively worthless. Which basically means that a huge amount of very
expensive wiring and electronics is going to rust, waiting for new ideas that
can harness it. Maybe waiting forever.

"We had such a splurge" on these networks "that it could easily be into the
2010s and not the zeroes when we need more," said Reed Hundt, the former FCC
chairman.

The largest barrier to consolidation may be the most obvious: "We're nowhere
near the bottom," said Scott Cleland, an analyst with Precursor Group. Assets
have been whacked to smidgens of their former worth, but another round of
bankruptcies could make them cheaper still.

The next round of bad news could come in the mobile telephone industry, which is
also saturated with competition and debt. Despite huge losses, carriers continue
to wage an expensive battle for customers and market share.

Most U.S. cities have six to seven carriers, while economists say only four or
five can be sustained. This has dropped prices to some of the lowest levels in
the world. Americans have taken advantage, using 500 to 600 minutes of wireless
service a month per consumer, or 3 to 5 times the rate in Europe, said Frank
Governali, an analyst with Goldman Sachs and Co.

But the prices are also below profitability. "There are few places in the world
where wireless is as destructively competitive," Governali said. Without
consolidation, the industry is sure to see "another disruptive cycle, where
you're destroying jobs, equipment vendors and creating all sorts of havoc for
the economy."  Phone Giants Stand Tall

The local telephone giants are the only ones with money left, and they may have
little need to buy out their failed competitors. They have their problems -- the
recession cut revenue, the cable industry is winning the battle for broadband --
but they also own the one commodity in short supply: Direct billing
relationships and wires to their customers.

They already own the largest mobile telephone businesses -- Verizon Wireless and
Cingular, a joint venture of SBC Communications and BellSouth. Among analysts
and industry executives, the conventional view is that they will likely capture
the bulk of customers as they move into the long-distance business state by
state, and as their former competitors fail, and leverage their strength as they
market the full range of communications services. Old distinctions between
wireless and land line, between long distance and local, will disintegrate. Flat
pricing will become common for the full bundle of services, and consumers will
pay more. The Bell companies have said competition is safeguarded by the
presence of cable companies that sell high-speed Internet service and, in some
cases, local telephone service.

"Going forward, we'll see consolidation and the emergence of oligopolies with
higher prices," said Noam, the Columbia professor. "Government will either look
the other way or permit stabilizing prices or whatever the euphemism would be."

Even if conditions alter, a more fundamental issue may hold up competition: The
rollicking ride of the past few years has left many customers weary of change.

"Five years ago, when you tested the marketplace, people were very open to new
companies serving them," said Alex Mandl, a former AT&T president who went on to
lead Teligent Inc., a now bankrupt upstart local telephone and Internet company.

"They were tired of the Bells and they were ready to try something new," he
said. "Well, now they've all tried something new and it hasn't been a pretty
experience."