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The following article appeared in Left Business Observer #101, July 2002. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.
Nomi Prins is a former investment banker turned journalist, based in New York.
It took a colossal $3.8 billion earnings restatement for a flailing telecom to grab a front-page headline from something Enron-related. Before June 26, if you mentioned Enron, Martha Stewart or Tyco to anyone, you got instant recognition plus mumblings about corporate corruption. When you asked whether disintegration of the entire telecom industry poses a greater threat to our economy, you got a blank stare.
That changed when WorldCom announced it had overstated earnings since the beginning of 2001. WorldCom carries half the world's internet traffic, and about a quarter of our domestic long-distance. Unfortunately, WorldCom's scam was reported by WorldCom, not the SEC investigating their books and not the Wall Street analysts. Not something that should boost confidence in the system which, the New York Times assured us recently, is working as it should.
The telecom sector is comprised of the so-called Baby Bells (the regional offspring produced by the 1984 breakup of AT&T), a collection of long-distance providers and equipment makers, plus an unregulated constellation of companies that created a stunning glut of capacity fed by a mega-glut of Wall Street money, encouraged by an army of cheerleading economists and pundits, led by George Gilder, manic prophet of the imminent telecosm. (Gilder, whose recommended stock portfolio is down over 90%, is personally broke, and has a lien against his house.) Companies bloated their balance sheets with fake trades, overstated earnings, and exaggerated customer bases. They hid losses and avoided taxes in offshore subsidiaries. More people have been or will be affected by the telecom epidemic than any other economic accident of the last 25 years, be it in lost pension value, disrupted service, higher rates, or unemployment.
Over the past 18 months, the telecoms industry rang up $110 billion in bankruptcies - a quarter of all corporate defaults over the same period, and double the pricetag of the 1980s S&L crisis. Since domestic deregulation in 1996, followed by global WTO liberalization in 1998, entities like Global Crossing, 360networks, Winstar, PSInet, Exodus and other doomed novelties were spawned. Their goal was to build global fiber optic networks that would meet all future communication needs, real and imagined. Forget that fiber cables had already been built by the energy companies, alongside their old gas pipelines, almost a decade earlier. A shining example, Williams Communications, a spinoff of the its pipeline parent, filed for bankruptcy in April.
These emerging carriers distributed immense wealth to an unsavory pack of executives, bankers, and other hellspawn before crashing in a catastrophe of plummeting shares, SEC investigations, and layoffs. During the late 1990s, the largest fifteen emerging carriers went on an acquisition spree - Global Crossing's taking of Frontier, Qwest's of US West, WorldCom's of MCI - using shares of their inflated stock as means of payment. They sucked the acquired companies dry to fund further growth in what became a capacity trading business. (That is, lacking any paying customers, and having no serious plans for acquiring any, carriers simply traded cable bandwidth which each other, booking these deals as revenue when no cash was actually changing hands. It was a racket while it lasted.) Telecommunication executives walked away with billions. Workers and consumers will be forced to pay for their orgy with lost pensions, lost jobs, and increased service costs.
In the five years leading to its chapter 11 filing, Global Crossing built an immense pile of debt. Investors, with the help of Wall Street underwriters, happily financed its quest to dominate the world's fiber optic networks. And it boomed - the youngest firm ever to qualify for a NASDAQ listing. To quote chairman Gary Winnick, "what has been most impressive is the rate of our growth."
Indeed. While the value of stock outstanding went from zero to $47 billion - all floated on $12.4 billion in debt. It aligned itself with the big boys, getting seed money from CIBC, the giant Canadian bank, to whom it returned the favor with $55 million in fees, a $1.7 billion return on their $41 million investment, and five seats on the board. Global Crossing got Jack Grubman at Salomon to praise their stock price up, Chase to scrounge up sizeable credit lines, and Goldman Sachs to scare up mega-investors like Microsoft for its Asian expansion. All told Global Crossing insiders and execs walked off with $5.2 billion - vs. $1 billion at Enron.
Now there is emerging evidence of paper shredding back at the Global Crossing offices. Spokespeople for Global Crossing emphasize, "Nothing that was shredded was material to the SEC investigations". Winnick, who sold three large chunks of shares right before the Frontier merger announcement, before a massive new share issuance and the day after the IPO, has not yet been called to testify in front of the SEC or Congress. His day will come.
When speculative money retreated in mid-2000, the house of cards toppled, wiping out $2.8 trillion in stock market valuation (an amount equal to 27% of GDP). The NASDAQ telecom index plummeted 92% from its highs in March 2000, more than any of its other indices. But it's not just capital that's taken the hit: the industry has announced 545,000 job cuts. During 2002, more than one out of four layoffs has come from the telecom industry, compared with just one in 17 in 2000. The number of cuts is 27% higher than in the first half of 2001, during which telco bankruptcies stood at only 12% of today's levels.
By mid-2001, there were 20.1 million fiber miles available for sale globally. Today, 5% of that is in use. Most of the emerging carrier companies have either gone bankrupt or are on their way.
Every day, another telco contemplates chapter 11. Every few weeks, one winds up in bankruptcy court. NTL and Metromedia Fiber went bankrupt in May. NTL became the second largest telecom bankruptcy with $16.8 billion assets, before being bumped to third place by Adelphia Communications in June. Adelphia inflated reports of its customer base for years, while the Rigas family siphoned off $3.1 billion in loans to themselves. Adelphia filed for chapter 11 on June 26.
WorldCom, whose shares hit penny stock status, probably has moments left until bankruptcy. WorldCom is tottering under $30 billion in debt and had its rating downgraded to junk in April. All of which spelled impending implosion anyway, but the gem about its creative expense accounting will hasten the timing. With $103 billion in assets - half of them in so-called "goodwill," such as the imaginary value attributed to brand names - it's a steep descent. But it took a 91-cent price for Jack Grubman, Salomon Smith Barney's telecom analyst extraordinaire, to downgrade his view from "neutral" to "underperform." How could New York attorney general, Elliot Spitzer have ever called Grubman, the bubble's biggest promoter on Wall Street (whose firm just happened to have floated the securities of some of today's biggest wrecks), biased?
Qwest, the smallest Baby Bell, and wannabe fiber optic player can't find cash fast enough to service its $26 billion debt. Qwest's ex-Chairman Philip Anschutz (who pocketed $1.9 billion during better years) and ex-CEO Joseph Nacchio were unceremoniously ousted. The only reason Qwest has not fallen yet is its USWest acquisition that provided actual customer revenue. They're pleading with the Federal Communications Commission (FCC) for long distance phone service access to the fourteen states where they provide local service and trying to convince consumers to think of them as USWest, stodgy phone call enabler. It's ridiculous that new CEO Richard Notebaert is being heralded as savior. He hails from Tellabs, which lost 92% of its market value during his tenure. Qwest, whose motto was "Ride the light," has hit a dark patch - a very dark patch, now that the federal government has announced a criminal investigation of the company.
WorldCom purchased MCI in a record $37 billion deal in 1998. It was the 67th in a string of acquisitions that CEO Bernie Ebbers engineered that was part of a grand growth by acquisition model aided by Wall Street. Shareholders in the firms Ebbers swallowed were paid not in cash, but with WorldCom's vastly inflated stock, which peaked at 95 in 1999. It's now almost worthless.
Ebbers resigned amidst SEC investigations in April. During his reign, he "borrowed" $408 million from his company while surreptitiously firing staff. Said one laid-off employee, "It was when the CFO [chief financial officer] spoke at the post merger meeting, that I realized WorldCom would fail. Before, the tone was about growing revenue and profits at twice the market rate. After, it was all about quarterly earnings per share." Cashing-out as fast as possible replaced the goal of long-term growth.
The latest round of layoffs will axe 17,000 people. WorldCom was thrown a $2.65 billion lifeline by its banks in April and was negotiating to double it. That was before news of their $3.7 billion scam was exposed in late June. "Our senior management team is shocked by these discoveries," declared current CEO John Sidgmore (who has been at the firm five years.) "We are committed to operating WorldCom in accordance with the highest ethical standards." Apparently ethical standards mean different things to different people.
Service providers who fed on the success of the carriers are near death. Ciena, whose customer list looks like a who's who of bankruptcies, has seen a 97% reduction in value. The tried and true telecoms are also feeling the heat of the chapter 11 volcano. AT&T shares are at historic lows, and the company is gradually being broken into pieces and sold off. And it's now being outmaneuvered at lobbying Washington by its thriving progeny. With billions of dollars of declining goodwill on its balance sheet and increased competition for long distance customers, AT&T will have a tough time generating enough cash flow to pay off its debt. The company endured another blow when the FCC decreed Verizon could offer long distance service to 74% of their customer base. AT&T has resorted to giving away free cell-phones in return for business.
It's not just the U.S.; globally, many telcos are crashing too. Over the years they all relied heavily on each other for profits - or the appearance thereof - in a failed testament to globalization. France Telecom is reeling under $68 billion in debt and its shares have lost 96% of their value. Owned 55% by the French Government, it may be the first telco to receive a bailout, which might make the French think twice about deregulation. Amsterdam-based KPNQwest announced a network shutdown in June. Nortel (nominally Canadian) and Deutsche Telecom are trading at record lows.
How can the entire communications financial and physical infrastructure be eroding and still not receive appropriate media coverage? The answers are disturbing.
First, no one really understands the jargon of the sector. The further we go from a simple phone-call, the more convoluted it becomes: ILECS, CLEC, RBOCs, DSL, broadband, optical loops. The industry went from a regulated monopoly (pre-1984) to a deregulated economic disaster (present) and is headed for unregulated monopoly status led by the last players left standing once the music stops. The un-chic Baby Bells, who plodded along the perimeter of new technology while all the mid-90s upstarts sprouted, are going to emerge victorious. Then they'll hike prices. Verizon already raised its local phone service by 11% and long distance service by 37%.
Congress has been spectacularly complacent about the issue - not a surprise, given the sector's generosity. According to data from the Center for Responsive Politics, telecoms and info tech donated over $366 million to their favorite political deregulators throughout the 1990s, half again as much as energy and natural gas.
There hasn't been a peep on Capitol Hill about reregulation. On the contrary, the House passed a bill (championed by Republican Billy Tauzin and Democrat John Dingell) in February that would allow the Baby Bells to offer broadband internet access over long distance lines without opening their local lines to outside competition, a step closer to full control.
Wall Street - source of a staggering $950 million in political contributions since 1990 - doesn't want the full story out either. Investment bankers took in $13 billion in fees from telecoms companies over the last five years. They spurred a merger and acquisition mania: $1.3 trillion spent on 1,670 deals. The telecom bubble enabled Wall Street to grow its retail customer base and sell inflated post-IPO stocks to starry-eyed investors. Now these banks are laden with nonperforming loans that could lead us into another banking crisis.
The media has its own business reasons for discretion. The broad communication sector is defined as Telecom, Cable and Media - all information providers. According to Herb Hauser, CEO of Barnes Wentworth, Inc Technology Engineering, "Information is the 4th utility. It touches everyone." As such, it's easy to see why the media would hesitate to point out the magnitude of its own potential destruction. When you take a look various newspaper boards, the interdependency becomes clearer. One of the New York Times Co. directors is a media and telecom partner at the Carlyle Group; another was a former CEO of Lucent.
> The promise of mammoth information transfer fueled the boom. The overbuilding, accounting manipulation, and dead dark fiber circling the world made the crash inevitable. Ironically, the only way for some of these companies to survive is to declare bankruptcy and shed debt.
And it's going to be a long, painful shakeout before we hit bottom. At the moment no one is showing leadership or offering a clear way out - not on Wall Street and certainly not in Washington. When the smoke clears, the market will have consolidated into a few monopolies.
As such, the Bells have taken every opportunity to up their lobbying efforts, and to free themselves from the remaining regulations they operate under. They are engaged in a battle to get the Tauzin-Dingell broadband bill through the Senate. After Sept. 11, Verizon told federal regulators that its success in restoring Lower Manhattan phone service showed that only a big company had what it takes to navigate disaster. In November, SBC Communications put William Daley, the former commerce secretary who ran Al Gore's 2000 presidential campaign, on their payroll with a $1.1 million sign-on bonus. Billy Tauzin's son is a lobbyist for BellSouth in Louisiana.
Washington hasn't even acknowledged that any of the problems of the sector have any commonalities beyond a few bad CEOs. The reality is the 1996 telecom act failed to produce the consumer benefits it promised. Surviving phone companies will raise their rates and shed jobs to remain viable. Yet, as long as the checks keep coming in, Republicans and Democrats alike will let it all just roll along.
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