Analysis: Networking industry braces for aftershocks

A string of gloomy financial news from the telecom sector, highlighted by two bankruptcy filings, has raised the specter of more consolidation in the service provider industry and spells more trouble ahead for the reeling networking industry, according to industry experts.

The week of tumultuous telecom news started with a bang when Bermuda-based Global Crossing, a provider of IP-based network telecommunications services, announcing it had filed for Chapter 11 bankruptcy protection. To follow was McLeodUSA Inc., of Cedar Rapids, Iowa, an independent competitive local exchange carrier serving 25 states, which announced Thursday it too had filed for Chapter 11 bankruptcy protection.

Adding to the bad news, the carriers have revealed plans to significantly cut back equipment-spending plans for 2002, which is bound cause networking vendors further revenue heartache, analysts said.

McLeod is looking to wipe out US$3 billion in debt from its balance sheet, while Global Crossing plans to eliminate $12.4 billion. And if the bankruptcy plans are accepted by shareholders as expected, many network equipment providers won’t see a dime of what they are owed.

“This is certainly going to hurt the equipment providers,” said Muayyad Al-Chalabi, director of packet services, at RHK Inc., a South San Francisco, Calif., telecommunications analyst firm. “This is going to hurt their balance sheets.”

Lucent Technologies Inc., of Murray Hill, N.J., claims they are owed at least $123 million, a number much greater than the $31 million listed in Global Crossing’s bankruptcy filing, The Wall Street Journal reported Friday. The filing states Paris-based Alcatel is owed $31 million; Nortel Networks, of Ottawa, Ontario, $13.8 million; Cisco Systems, of San Jose, Calif., $12.6 million; and Juniper Networks, of Sunnyvale, Calif., $3.6 million.

However, it is noted that Lucent claims they have taken sufficient provisions, an accounting practice in which a company anticipates problems with a customer, thus keeping their balance sheet clean, said Ariane Mahler, an analyst with Dresdner Kleinwort Wasserstein, the investment banking division of Dresdner Bank, based in London.

However, losing money in the short term from unpaid debts is the least of their worries, said Mahler.

“Where are the future revenues going to come from?” asks Mahler. “Next-generation equipment vendors like Ciena, of Linthicum, Md., and Juniper are losing customers. They are dependent on these next-generation carriers.”

Making it even more difficult for network providers, established carriers – Verizon Communications, Qwest Communications, BellSouth, and SBC Communications – outlined their sharply reduced capital spending plans this week in fourth quarter financial reports for 2001.

Together, the four largest local carriers plan to spend between $33.7 billion and $35.4 billion, according to their predictions. Last year the carriers spent about $43.1 billion, which means the carriers expect to spend from 18 percent to 22 percent less this year on network upgrades, new switches and the business infrastructure used to manage a phone company.

The lack of new revenues from bankrupt service providers is exacerbated by the fact that some of the future bankrupt carriers will be liquidated and their assets, namely networking equipment, will be auctioned off. The effect here is that carriers will buy the used equipment at cost, rather than buy new. Mahler adds that eventually these liquidations will depress the prices of equipment, further hurting their revenues.

While the equipment vendors are being hurt, it doesn’t seem likely that the ripple effect will impact end user customers in the short term. Both McLeod and Global Crossing have stated that they will continue to operate their services during the restructure.

Global Crossing plans to emerge from bankruptcy via a $750 million investment from Hong Kong-based holding company, Hutchison Whampoa, and telecom provider Singapore Technologies Telemedia. Upon completion of its bankruptcy proceedings, the investors will each own 30 percent of the company.

Meanwhile, McLeodUSA will receive $175 million from buyout firm Forstmann Little. Upon completion, Forstmann Little, of New York, will hold an approximate 58 per cent share of the company.

Wireless winners

If there were any winners in this scenario, it may be the wireless carriers. With far less competition and actual profits, wireless carriers will continue to see a shift of data traffic from wireline networks to their own.

Verizon Wireless, of New York, announced this week it launched its Express Network, a new wireless 3G network based on equipment supplied by Lucent Technologies. Verizon is using Lucent’s 3G1XRTT technology, which Lucent says may potentially double the voice capacity of the network and increase transmission speeds by nearly ten times.

At the same time, Verizon reported losses of $2.0 billion for its fiscal fourth quarter. In the same period of the previous year the company reported a net income of $1.9 billion. The company attributes the losses to a variety of things, including severance costs for the reduction of approximately 10,000 employees, charges in current market values of investments, and of course the recent economic events in that country.

Chidi is a U.S. Correspondent for the IDG News Service