Telecom headed for bankruptcy reruns?

As MCI, the highest-profile of the telecom bankruptcies, prepares to emerge from Chapter 11, the industry faces many of the same problems that existed before the bubble burst.

Marguerite Reardon
Marguerite Reardon Former senior reporter
Marguerite Reardon started as a CNET News reporter in 2004, covering cellphone services, broadband, citywide Wi-Fi, the Net neutrality debate and the consolidation of the phone companies.
6 min read
The telecommunications industry has made substantial progress in putting a disastrous string of bankruptcies behind it, but analysts are warning of further trouble ahead.


What's new:
While MCI and other telecom companies are emerging from bankruptcy with less debt and squeaky-clean balance sheets, the industry overall is still mired in problems.

Bottom line:
Getting rid of debt and cleaning up balance sheets are only half the battle, analysts say. Companies must also create new business models that focus on increasing revenue and profitability.

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Industry watchers are closely eyeing MCI as it prepares to emerge from Chapter 11 bankruptcy protection later this month, an event that will mark the end of the highest-profile reorganization to hit the sector in recent years. Few are popping champagne corks, however, as the industry braces for yet another painful round of consolidation.

Since 2000, 68 publicly traded telecom carriers have filed for Chapter 11, according to BankruptcyData.com. Most of those carriers are still in business and many--including 360networks, AboveNet (formerly Metromedia Fiber Network), Global Crossing and XO Communications--have recently emerged from bankruptcy with greatly reduced debt burdens and squeaky-clean balance sheets.

While these companies are starting over, the industry as a whole is still mired in problems. Over the past three years, analysts say, the overall financial fundamentals of the telecom industry haven't changed much.

There is still far too much competition, they say, and the glut of capacity that resulted from overzealous network projections still exists. As a result, prices for traditional voice-calling and wholesale bandwidth sales are plummeting. In addition, carriers continue to lose huge amounts of money every quarter. Even the behemoth Baby Bells are struggling to make profits.

"I've been disappointed at the lack of consolidation in the industry," said Tavis McCourt, an equities analyst with Morgan Keegan. "Chapter 11 has its benefits for the individual companies. But for the industry, it has been negative. All these players have gotten rid of debt, but the assets haven't been consolidated. Nothing has changed."

MCI, previously known as WorldCom, is one of the biggest examples of how the telecom industry went awry. Its emergence from bankruptcy is being closely watched.

Back in the boom times, the company was one of the most aggressive carriers, racking up $41 billion in debt to acquire assets and build out infrastructure. After the accounting scandal that centered on billions of dollars in overstated profits came into public view, the company succumbed to the mounting debt and filed for Chapter 11 protection in July 2002.

Creating new revenue
MCI recently launched additional managed services geared toward its business customers, such as security, and virtual private networking (VPN) that uses a technology called multiprotocol label switching (MPLS). But the company still generates much of its revenue from commoditized long-distance voice and data transport services.

Before the Chapter 11 reorganization, MCI competed mainly on price, something analysts expect it will do again as it emerges from bankruptcy with a clean balance sheet. A pricing war would likely hurt competitors, such as AT&T and Sprint. But it would also hurt MCI in the long run. Given declining gross margins on its transport services, price cuts won't be enough to make the business profitable.

"MCI still has a number of businesses that are seeing negative trends," McCourt said.

Therein lies the problem, according to analysts. Getting rid of debt and cleaning up balance sheets are only half the battle. Companies emerging from Chapter 11 must also create new business models that focus on increasing revenue and profitability.

"The last few years have been an awakening for everyone in the space," said Carl Grivner, CEO of XO Communications, which emerged from bankruptcy in January 2003, having shed all but $500 million of its original $5.3 billion in debt. "Becoming cash-flow positive has got to be the ultimate goal."

Greg Maffei, CEO of 360networks, and Bill LaPerch, CEO of AboveNet, agree.

"No one is building on speculation anymore," LaPerch said. "We build on demand and generate revenue right away. It sounds simple, but it's a significant change from the way things used to work."

Changing their ways
These executives said that in order to survive in the postbankruptcy world, they have changed the way their companies do business. AboveNet, which has built underground fiber rings in every major city around the country, originally sold its capacity wholesale to other carriers. Now, LaPerch said, more than 80 percent of its business is coming from direct sales to corporate customers. The company is also focusing on emerging technologies like metro Ethernet to win new business.

360networks and Global Crossing, which had built extensive international fiber networks, also sold wholesale capacity in their prebankruptcy days. Today, these companies said they are also focusing on business customers. In addition, Global Crossing said it is zeroing in on new technologies, such as voice over Internet protocol (VoIP).

"The end-user market looks like it's getting stronger," Vik Grover, an equities analyst with Needham, said. "Carriers that are addressing enterprises directly are seeing very good success rates."

Some carriers are trying to force consolidation in the market. 360networks and XO Communications have leveraged their newly clean balance sheets to acquire distressed assets from other bankrupt carriers and are using them in their new business models.

360networks is putting to work assets bought from GT Group Telecom, Touch America Holdings and Dynegy to focus on medium-sized businesses in remote parts of Canada. The company still sells wholesale capacity, but only on a limited basis. In February, XO Communications outbid Qwest Communications for Allegiance Telecom, a local exchange carrier that was in Chapter 11. It paid $311 million in cash and 45.4 million shares of XO common stock for Allegiance's assets, which it plans to use to expand its presence in the market and to refine its focus on large enterprise customers.

Carriers buying these distressed assets say that adding new pieces to their network can help them expand their business while also helping them cut costs.

"Most of the assets out there aren't really worth the original cost to build them," Maffei of 360networks said. "But if the price is right and you can integrate them into existing billing systems, you can take a lot of cost out of the business."

But Maffei said it will be more difficult in 2004 to find good deals, in large part because everyone is out looking for them. He said that companies such as XO Communications--which bid unsuccessfully for assets from Global Crossing and Cable & Wireless--are driving up prices.

Still too early
So will these strategies work? It's still too early to pick winners and losers, say analysts. But there are early indications that some companies emerging from bankruptcy could already be headed for trouble. Earlier this month, Global Crossing reported a record-breaking $25 billion quarterly profit for the fourth quarter of 2003, but all of these gains were linked to its emergence from Chapter 11. None of this profit came from the company's actual business--it reported operating losses.

What's more, Global Crossing reported that revenue in 2003 was down 6 percent, compared with the previous year. Its CEO, John Legere, said on a conference call with analysts last month that the company is looking to raise an additional $100 million in financing. It is also trying to sell its Global Marine installation and maintenance services business.

Despite its aggressive expansion strategy, XO Communications recently reported disappointing results: for example, sales in the fourth quarter were down 13 percent from a year ago. And the company continues to lose money, although its losses narrowed from last year. But the company is optimistic that its new business model will bear fruit. Executives estimate that total 2004 revenue will show an increase over annualized fourth-quarter 2003 results.

The biggest problem facing carriers is that there is still too much competition, analysts say.

"No one really went away in this market," analyst McCourt said. "These companies went into bankruptcy, but they're all still around trying to serve some segment of the market with the same assets."

While it's obvious that more consolidation is needed, it's not easy to predict which carriers will be making big purchases.

SBC Communications and BellSouth, which co-own Cingular Wireless, will be busy closing the proposed merger between Cingular and AT&T Wireless. Qwest Communications has its own financial problems to handle. Verizon Communications, the strongest of the Baby Bells, doesn't need to make a big deal.

Even though AT&T's financial fundamentals appear to be stabilizing, the company has had a long period of underperformance and is probably not looking for any big purchases. Sprint, which is now recombining its "PCS" wireless tracking stock with its general "FON" stock, is considered more of a seller than a buyer.

If no one is buying, what will happen? Analysts say that the industry will likely enter another round of carrier bankruptcies.

"One way or other capitalism will win," McCourt said. "Consolidation will eventually occur. These companies will likely go back into bankruptcy, and the assets will be too cheap to pass up."