The competitive telephone industry has stabilized but is still bleeding losses and remains in a “tenuous” position, says an association representing the sector.
Of 21 public companies surveyed by the Association of Local Telecommunications Services, 18 improved their earnings before interest, taxes, depreciation and amortization (EBITDA) in 2002. Combined, they posted $290,000 in positive EBITDA, compared to a negative $1.1 billion EBITDA the previous year.
Those companies surveyed narrowed their losses last year, although the results are somewhat misleading due to two bankruptcy restructurings, says ALTS. The 21 companies recorded a net loss of $1.5 billion last year, compared to an $8.5 billion loss in 2001.
However, only four of the companies surveyed posted profits, and two of them — ICG Communications Inc. and McLeodUSA Inc. — reported high gains last year during their bankruptcy restructurings. The McLeodUSA gain recorded during its bankruptcy was attributed to the restructuring of debt partially offset by reorganization charges. An ICG spokesperson could not be reached to discuss gains during its restructuring period.
For the first quarter ending March 31, 2003, ICG reported $2.3 million in net income. McLeodUSA posted a net loss of $84.1 million, or 31 cents per share, during the same period.
“In summary, the financial condition of the CLECs as a whole has stabilized although it is still quite tenuous,” states the annual ALTS report. The companies “remain extremely vulnerable to fluctuations in the market, to regulatory decisions and to the overall economic health of the nation.”
Analysts for New Paradigm Resources Group Inc., a research firm that contributed to the ALTS report, say the phone companies are poised for a comeback in the latter half of the year and in 2004. Craig Clausen, COO and senior vice president of NPRG, says the CLECs have abolished much of their debt through restructurings and improved their operations by contracting and focusing on sales and marketing.
“They are much more familiar with the markets in which they operate,” Clausen says. “They are all operating as if they are sober now. Before it was all a drunken stupor.”
The CLEC industry grew revenue to $51.86 billion in 2002, up from $48.01 billion the previous year, and controlled a 13.2 percent stake in the local switched telephone market as of the end of last year, according to NPRG and Federal Communications Commission data.
Although the flood of bankruptcy filings by telephone companies over a three-year period has subsided, financial woes continue to mark the sector. Allegiance Telecom Inc., long regarded by analysts as a star among its embattled peers, filed for bankruptcy in May after failing to reach an agreement with its creditors to slash its $1.2 billion debt load in half.
Even the companies that have emerged from bankruptcy are not out of the woods. They still must fund their operations, and their debt — though it is a fraction of what it once was — eventually will come due. Approximately $60 billion of the telecommunications industry’s $300 billion in debt matures in 2005, says Ernst & Young Corporate Finance Managing Director Eric Carlson.
Facilities-based CLECs owe at least a portion of that debt, and some companies say they will need to access the capital markets to meet their obligations. ICG, for example, wrote in a regulatory filing it anticipates needing financing in 2005 and 2006 to refinance its secured notes and senior subordinated term loan.
CLECs must demonstrate to investors they are moving closer to free cash flow — the ability to fund operations on their own — if they expect to access the capital markets and repay their debt obligations, says Mike Weaver, an analyst with Fitch Ratings.
“It would increase investor confidence in their business plan,” he says.
However, cautions the analyst, there is a wildcard: the economy.
Todd Rosenbluth, telecom services equity analyst with Standard & Poor’s, says an improvement in the wireline sector will lag a recovery in the general economy. S&P, he adds, sees the unemployment rate peaking at 6.2 percent in the fourth quarter of 2003.
“We think the recovery in telecom will be at least six months out after that,” says Rosenbluth.
Some investment firms say consolidation is in the cards for CLECs.
Peter Claudy, a general partner with M/C Venture Partners, says consolidation has to occur among companies competing in the same territories. “You basically speed up the time it takes to get to free cash flow positive,” says Claudy, whose firm has been investing in the emerging wireline business for 10 years. “It’s a more valuable business in terms of the market position and some day would be of interest to a buyer if you have a greater share of the market.”
The biggest inhibitor to mergers and acquisitions, he says, is the balance sheet, specifically the debt level of companies. “If a company is leveraged it makes it that much more difficult to put the companies together,” he says. “There are a lot of stakeholders that don’t agree.”
Kevin Fechtmeyer, managing director of Shattan Group LLC, a private equity firm, says any CLEC with less than $100 million in annual revenue is bound to merge with another or be acquired. “I think dialogue has escalated. Closings have not though,” he says.
Clausen says the key driver behind consolidation will be a complementary footprint. “Everyone knows this [consolidation] is the course of action the industry has to take” but it is “so difficult to find the right match of facilities,” he says.
XO Communications Inc., which emerged from bankruptcy in January, says it had found such a match: Global Crossing Ltd. Led by its billionaire Chairman Carl Icahn, XO made numerous offers to acquire the bankrupt network service provider, and its debt.
As of June 30, XO had yet to convince Global Crossing to drop plans to sell a majority stake in the company to Singapore Technologies Telemedia Pte. XO says Global Crossing’s senior lenders had tendered an offer to sell a portion of the $2.21 billion in outstanding loans, leaving XO as the owner of $790 million in principal debt, according to preliminary results.
XO sought to acquire the debt because it gives the company a significant voice in voting on a new reorganization plan if U.S. regulators do not approve the ST Telemedia agreement or if it falls apart for some other reason, says a source. Before the tender offer, XO owned $294 million of Global Crossing’s debt.
