Volume 67, Issue 7

The Telecom Upheaval: Adventures in the Twilight Zone
by Dr. Peter M. Sperling

Just about every conscious person knows that, after a long period of economic expansion in the 1990s, the U.S. economy experienced a relatively mild recession and has been inching its way into recovery (we hope!) over the past year or so.  Some sectors of the economy remain battered, however, and are likely to remain so for some time.

Aside from the “dot.com” implosion, perhaps the prime sector that continues to show significant weakness is telecommunications.  What makes the hardship even greater in this sector is that it started with the service providers – the companies that provide local, long distance, and wireless service to individuals and businesses – and then, inevitably, spread to the companies that manufacture equipment and systems for the service providers.  Since my almost thirty year business career was spent in both areas, I can give Commentator readers a bit of the flavor of what it was like living through some incredible changes.

There was enormous excitement in the air when I left AT&T (after about 25 years) to join Lucent Technologies in early 1996.  Competition among traditional long distance providers (like AT&T, MCI WorldCom, Sprint) was vigorous, which meant good sales for telecom equipment manufacturers.  Wireless service providers were expanding very rapidly, fueling a boom in the manufacture of cellular equipment, and foreign service providers were being partly or wholly privatized as well as facing newly allowed entry by start-up competitors.  Everything looked extremely rosy for equipment manufacturers.

Not only for equipment manufacturers - in fact, the lure of rapid technological change (think “broadband”) leading to expected explosive demand growth resulted in just as rosy an outlook from the service provider perspective.  The established providers, in turn, invested huge amounts of money to upgrade and expand their facilities.  At the same time, new firms were entering the service provider industry at a very rapid pace.  Companies like Global Crossing and Winstar, hailed by many analysts as the wave of the future, raised enormous amounts of money to create new networks and systems, much of it via debt.  And the existing service providers also borrowed heavily to fund their capital programs.

The end result should have been expected.  The new technology was over-hyped, demand didn’t grow quite as rapidly as expected, and capacity increased by many orders of magnitude.  Too much capacity chasing too few customers led to financial distress among established service providers and outright failures among the new entrants.  Both Winsatr and Global Crossing are bankrupt, along with many others.  Extremely large service providers, which have been around for decades, found themselves overextended and having to sell off assets in order to raise cash to pay down debt (France Telecom, Deutsche Telecom).  And the spillover to the equipment suppliers has been devastating.

Companies like Lucent and Northern Telecom (Nortel), once financially strong firms, now find themselves with debt that is rated at “junk” levels – and weak junk at that.  Even some of the strong foreign manufacturers have had serious difficulties; Alcatel (French), Erickson (Swedish), and Nokia (Finnish), all major competitors to Lucent and Nortel, have had problems.

I retired from Lucent a little over two years ago, just before the bottom really dropped out of the telecom sector.  Both Lucent’s and Nortel’s CEOs have been replaced (Lucent’s three weeks after I retired, but no cause and effect!), and both have slashed their workforces in attempts to lower their breakeven sales levels.  Ultimately, as the economies here and abroad pick up, and as excess capacity is worked off and technology continues to progress, the service providers will start to boost their capital spending and the equipment suppliers will, at last, start to see their fortunes improve.  The tricks, of course, is to be one of those firms that have managed to weather this disaster and thus are well- positioned to jump into the next cycle.  I hope my friends and former colleagues are employed by one of them!¨

Dr. Peter M. Sperling is Visiting Associate Professor of Finance at Yeshiva.

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