Who Said Chapter 11?

Posted: Wednesday, November 19, 2008
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Author: pradhana
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Filed under: Business Analysis

By David Molony, principal analyst at Ovum

Who will bail out the first credit-troubled telco? A new Ovum report shows which operators and vendors are in the most exposed cash management positions going into 2009. A telco failure might seem unthinkable, but it has happened before, and the survivors were those that rebuilt based on enterprise services. They could do so again, but it will be harder work this time.

Learning from the dotcom bust
For telecoms operators, one lesson of the 2001 dotcom crash might have been that failure was a fast track to renewed profitability. It wasn’t of course, as we’ll explain. It begs the question for 2009, though. The issue is not just which telecoms operators might face a funding crisis over the next year, but this: when the first big telco fails, what will the rescue package look like?

In a new survey of the financial condition of telecoms equipment vendors and service providers (Credit crisis brings telecom to a turning point, available now on the Telecoms Knowledge Center), Ovum analysts say that “the collapse of Global Crossing and other undersea network-based players…during the bubble burst of 2000–2 scared investors away from business models appearing aimed at creating truly global telecom firms.”

Global Crossing was certainly one of the sickest telcos when it entered Chapter 11 bankruptcy protection proceedings in 2002. But it was only getting started.

For the year to December 2003, Global Crossing filed accounts at the Securities and Exchange Commission recording audited net profits of $25.47 billion, making it by far the most profitable telecoms operator in the world. The next most profitable telecoms operator that year was MCI which, as Worldcom, had also sought Chapter 11 protection in 2002, yet was able to record net profits of $22.2 billion for 2003.

Both companies had been able to restate earnings under a so-called ‘fresh start’ accounting rule that allowed companies emerging from Chapter 11 proceedings to write back their debts to the P&L accounts. In Global Crossing’s case that was worth $24 billion.

That outcome shocked many people in the industry at the time, who pointed out that it just wasn’t a realistic representation of the financial robustness of Global Crossing versus the world’s leading telcos. It could be dismissed as an accounting aberration even today, but that doesn’t change the SEC records.

But Global Crossing and MCI were able to continue in business. Global Crossing is today providing secure networking for the General Services Administration and the UK’s Foreign and Commonwealth Office, as well as a host of manufacturing, transport and services companies. MCI, as Verizon Business, is today one of the big five global service providers for enterprises and public sector organisations.

Business users to the rescue?
Arguably there was a key factor in Global Crossing and MCI’s survival and continuation: they were both enterprise service providers with major contracts for federal government and corporate customers. It did not seem to matter so much to financial authorities when consumer service providers went under, as many broadband ISPs discovered.

In enterprise telecoms, we believe enterprise customers will continue to spend on managed telecoms solutions. In helping their own businesses they will help telecoms services providers:
Telecoms and managed IT helps companies reduce their cost per transaction.
This helps them to reduce the corporate cost of business too.

Telcos are increasingly able to deliver next-generation services which will interest enterprise purchasing departments – e.g. on-demand services.

Telecoms services providers are increasingly integrating between business and consumer (B2B2C) – e.g. messaging and video clients.

Telcos are extending the reach of more of their services to global markets – e.g. managed LAN and managed desktops.

It is true that enterprise spending plans are still the unknown in the current economic climate, but our initial interaction with MNCs suggests they will start to look for a savings contribution from ICT in the overall cost-reduction programmes they are considering.

The credit crunch does not have to be a total shock to the telco system. Most have capital spending under control versus 2000, with capex ratios in the range of 16–20% of sales.
In addition, most telcos have enough free cash flow (as opposed to cash on account) to meet capital repayment schedules and pay dividends without using lines of credit themselves – all, that is, except perhaps BT, Telecom Italia and Portugal Telecom – while Deutsche Telekom and France Telecom have access to €13 billion and €9 billion lines of credit respectively.

We have had several enquiries from clients asking what impact the crisis in the banking industry has had on operators’ activities, particularly for the enterprise market. We don't have much evidence one way or the other just yet. However, we would suggest that enterprise customers are at the stage where they are finding lines of credit tightening but have not yet decided whether that means cutting or suspending telecoms programmes.

One enterprise customer with a £300 million line of credit arranged 18 months ago has lately applied to draw down a scheduled instalment and been refused – even though it is a signed agreement. That doesn't mean £300 million just got taken out of telecoms spend, but it does mean there’s a CFO somewhere who now has a cash position to manage, and how they decide to do that might affect communications spending and investment.

Let’s be doubly careful here, because large enterprises are still ordering major communications networks, especially where they need to innovate or upgrade. A regional European operator has briefed us this month on new and significant investment commitments from financial services customers to new networking projects across London and five North American cities.

We don’t mean to overstate the case; the business sector won’t be providing a rescue spending package for telcos. Volatile markets and surprise government interventions don’t obscure the single clear and persistent condition: slower growth.

Expect enterprises to fall back to retrenchment programmes, as the early warning signs from SAP and other job-cutting IT services vendors show. Telco service providers will have to go to market with much improved service propositions to offset cost-focused negotiations.

This recession looks different from the 2001 shock because the downturn is likely to be across all sectors. Last time the telcos were able to respond by cutting spending on their own global and pan-regional network plans. This time the problem is out of the telcos’ hands and is wider. Accounting authorities and financial services vendors could have a lot less room to accommodate benighted telcos. /PR