News > Technology
Telecom turmoil
graphic December 18, 2001: 9:48 a.m. ET

Losses and bankruptcies make 2001 a year to forget for the telecom sector.
By Paul R. La Monica
graphic graphic
NEW YORK (CNN/Money) - This wasn't supposed to happen.

Sure, we all kind of knew in the back of our minds that the Internet stock mania couldn't last forever. Too many companies went public in the late 1990s with nothing more than a snarky marketing campaign and faint hopes of eventual profitability. But telecoms were more solid, a big part of the Internet revolution with real profits to boot. Stock prices were high, but there was no bubble, right?

Wrong. Big equipment providers like Lucent and Nortel posted staggering losses and laid off thousands of workers. And upstart telecom carriers hawking high-speed Internet access went bankrupt because they couldn't compete against the established giants.

It got ugly.

How it unraveled for equipment providers

What went wrong? The economic slowdown forced regional carriers like Qwest (Q: up $0.19 to $13.63, Research, Estimates) and Verizon Communications (VZ: up $0.21 to $48.57, Research, Estimates), in addition to already struggling long distance giants Worldcom (WCOM: up $0.07 to $15.42, Research, Estimates) and AT&T (T: down $0.22 to $16.80, Research, Estimates), to reevaluate their budgets for the year. As a result, unsold routers, switches and other telecom equipment piled up, contributing to earnings shortfalls for networking industry kingpins like Cisco Systems (CSCO: up $0.46 to $19.72, Research, Estimates) and Nortel Networks (NT: up $0.24 to $7.68, Research, Estimates) as well as upstarts like Ciena (CIEN: up $0.69 to $15.60, Research, Estimates) and Juniper Networks (JNPR: up $1.62 to $22.71, Research, Estimates).

It also didn't help that the equipment companies, eager to find new customers, engaged in risky vendor financing deals, loaning money to customers who in turn bought their products. "They were giving products away to startups and having startups lease equipment without doing credit checks. This came back to haunt the major equipment providers," says Eric Gonzales, partner with DCM-Doll Capital Management, a venture capital firm.

But of all the equipment companies, Lucent (LU: up $0.24 to $6.52, Research, Estimates), Nortel and optical components maker JDS Uniphase were clearly hit the hardest.

In May, Lucent was in talks to sell out to French networker Alcatel (ALA: up $0.13 to $18.05, Research, Estimates) but could not agree on a price. In order to raise money to pay down debt, Lucent spun off a portion of its opto-electronics component business Agere Systems, sold its fiber-optic cable manufacturing division to Furukawa and raised $1.9 billion through an offering of convertible preferred stock. (Lucent even sold its corporate golf course -- likely to the chagrin of many executives.) It still wasn't enough. Its stock cratered 55 percent as of December 14.

Nortel posted a mind-numbing $19.6 billion loss in the second quarter and lost $3.5 billion more in the third quarter. Like Lucent, Nortel laid off workers, raised money through a convertible offering and sold off assets. This has also so far failed to change the company's fortunes as Nortel is expected to post another big loss in the fourth quarter and bleed red ink in 2002 as well.

Finally, JDS Uniphase (JDSU: up $0.36 to $9.10, Research, Estimates), fat from a gluttonous acquisition spree in 2000 (the company shelled out $63 billion to buy makers of optical components, used to increase speed on telecom networks), reported a $7.9 billion quarterly loss in its fiscal fourth quarter (which ended in June) and had to write off a staggering $44.8 billion in assets.

Since the primary customers for JDS's products are equipment providers like Lucent and Nortel, JDS's woes were exacerbated and there isn't much hope for a rebound in sales and earnings anytime soon.

Sad demise for CLECs

Interestingly enough, Baby Bells like SBC Communications (SBC: up $0.14 to $40.07, Research, Estimates), Verizon and BellSouth (BLS: up $0.23 to $39.21, Research, Estimates) didn't just cause a meltdown for equipment providers; they were also responsible for the collapse of many smaller telecom providers known as competitive local exchange carriers (CLECs).

Companies like NorthPoint, Covad, PSINet and Rhythms NetConnections were Wall Street studs in 1999 and 2000 because they presented a viable alternative to the Baby Bells for services like high-speed Internet access through digital subscriber lines (DSL).

But all four, in addition to several other small telecom carriers, filed for bankruptcy this year. Some of NorthPoint's assets were acquired by AT&T and Worldcom is in the process of buying assets from Rhythms. Covad and PSINet are still operating under bankruptcy protection.

The main problem was that the CLECs had to lease copper lines controlled by the big carriers in order to provide their service. Although the Baby Bells were required by law to cooperate with the CLECs, such cooperation was not exactly a smooth process, often leading to delayed roll-outs of service for the CLECs. It also didn't help that the Baby Bells offered their own DSL products and had the power to undercut their smaller rivals by price.

The 2002 outlook: A modest comeback for stocks?

Enough depressing news about the year that was. What about 2002? Unfortunately, few are predicting a major rebound in capital spending next year. To that end, Qwest announced reduced spending plans for next year in mid-December.

Still, some prominent investors think that the sell-off in 2001 has finally created some values in the beleaguered sector. Bill Miller, manager of the Legg Mason Value Trust Fund, on pace to outperform the S&P 500 for the eleventh straight year, says that he purchased stakes in Lucent and Qwest in the third quarter of 2001. In addition, he also invested in fiber optic cable manufacturer Corning (GLW: up $0.35 to $8.86, Research, Estimates) and communications-software developer Comverse Technology (CMVT: up $0.25 to $20.68, Research, Estimates). The thinking is that stocks may rebound late next year on the hopes of better years ahead. "We do not expect a telco recovery in 2002 but we do expect a modest capital spending recovery in 2003," Miller says.

There is a logic there. Carriers can't hold off on new network upgrades indefinitely. "If you look out to 2003 and 2004 we will eventually get to a time where there will have to be a renewed effort to build out networks. Carriers are going to have to over-invest for a while in order to catch up," says Gonzales.

Not all CLECs will go under. The price drops in some of the more financially healthy CLECs were overdone says Chuck Royce, president of Royce & Associates, an investment firm that specializes in small-cap mutual funds. He mentions Allegiance Telecom (ALGX: up $0.25 to $7.88, Research, Estimates), which has $537.6 million in cash and Time Warner Telecom (TWTC: up $0.15 to $17.72, Research, Estimates), with $380.1 million in cash as two CLECs that he has bought for his funds recently. (AOL Time Warner, owner of CNN/Money, is an investor in Time Warner Telecom.) Shares of Allegiance and Time Warner have fallen 66.4 percent and 73.1 percent respectively this year as of December 14.

Still, even though investors can take solace in the fact that it will be difficult for the telecom sector to fare worse in 2002 than it did in 2001, the problem is that things may not get much better either. graphic