CHANGE
Looking for a path to profitability in the tumultuous telecommunications sector? Try bankruptcy. These days — thanks, WorldCom — everyone's doing it.
Counterintuitive? Sure. But consider the screwy picture of today's telecom industry: An insatiable demand for bandwidth incited a club of incumbent and unknown telcos into a speed orgy of fiber-laying. With traffic growing as much as tenfold each year, their stock prices soared, and the capital poured in. Then all that money changed the economics of the business. A flood of new fiber glutted the market, and bandwidth prices went into free fall — along with profits. Despite a still increasing demand for bandwidth, the industry has been crippled by the prospect of making insurmountable debt payments — what amounts to a half-trillion-dollar mortgage worldwide ($200 billion in the US alone).
Chapter 11 was designed in an earlier day, but it could hardly have found a better candidate for its resuscitation therapy. Restructuring under court protection allows a company to separate a good underlying business from a terrible capital structure. It's not without risk, to be sure, yet 85 percent of large, publicly traded firms that file for bankruptcy are able to set up a repayment schedule and get on with things. Realizing this, creditors — who would seem to be the big losers, typically recovering just pennies on the dollar — often push a firm to file. At the moment, the receivership trend is less a flight to safety, designed to bar wolfish bankers at the door, than it is prepackaged bankruptcy, negotiated in advance with creditors. In such cases, the court just serves as a formality. (Sadly, so do shareholders. But that's another story.)
FOR TROUBLED TELCOS, CHAPTER 11 ISN'T LIFE SUPPORT, IT'S SHOCK THERAPY
Strategic bankruptcy offers plenty of advantages. It can halt a financial hemorrhage at a time when a firm still has plenty of cash in the bank — as opposed to waiting until loans default, when it's often too late to rescue operations. It can actually make raising money easier, since post-bankruptcy debtor-in-possession loans get priority repayment. And management often stays in place, no doubt relieved at the prospect of running the business interest-free for years.
Telecom firms are testing the limits of this rosy thesis on a grand scale. Big bankruptcies hit a record last year, with 257 public firms wiping their balance sheets of $230 billion in debt. Communications companies have been among the biggest: Global Crossing, Williams Communications, Winstar, XO, and McLeodUSA. A May report by the Precursor Group identified 24 of 29 publicly traded telecom firms as being at risk of bankruptcy. A WorldCom filing could make 2002 a record year for total assets in receivership.
This will rightly be seen as evidence that the telecom industry is still in a shambles. But it's also an indication of how it might recover. Take Covad, a DSL provider, which went bankrupt in August 2001 with $1.4 billion in debt. Four months later, it was back, its books cleaned with a debt-for-equity (and cash) swap with its creditors. Revenue grew by 43 percent in the first quarter out of bankruptcy, and now Covad is one of the few independent providers economically able to offer DSL. McLeodUSA likewise recently reemerged from Chapter 11 with a scrubbed balance sheet and improved prospects.
As pleasant as erasing billions of dollars of debt may seem, it's not a miracle cure. The stigma of bankruptcy could send customers and suppliers fleeing; it's rather hard to spin Chapter 11 as a positive development. In the airline industry, which went through a rash of bankruptcies in the early '90s, the danger of attrition was lower because customers couldn't leave so easily. Airlines (especially those that got into financial trouble after having to serve too many unprofitable routes) are often the sole carriers for some connections, and many have long-term contracts on scarce landing slots. But switching long distance carriers is a lot easier. How many customers have already moved from MCI to AT&T out of fear that WorldCom will fold?
These days, however, it's hard to find a telco that isn't in trouble; the shock of seeing your carrier's CEO taking the Fifth may no longer be enough to spur a scramble for a new service. Certainly as more companies emerge from bankruptcy, the word will lose some of its sting. The firms that do it best will have tremendous advantages over debt-laden rivals. Spared of crippling debt payments, they can live on operating profits, and even raise money in a hostile capital market. How ironic: The most successful "first-mover advantage" could be to Chapter 11. If it works, a race to court protection could be a route to the industry's recovery, not its demise. What Moore's law was to the boom, bankruptcy law could be to the bust.
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