The bankrupt go bankrupt

The worst is yet to come in the telecom sector. Companies that have spent the past 12 months clawing their way out of bankruptcy will only go bankrupt again, killed by the continued decline in bandwidth prices.

Why It Will Happen
Two powerful forces are driving this trend: one economic, the other technological. Since October 2001, 17 companies, with a combined market capitalization of $96 billion, have filed for bankruptcy protection (Global Crossing and WorldCom being the most prominent). Now they’re busily working to settle their debts–paying off some creditors and stiffing others (depending on their debt agreements). With few exceptions, these companies will emerge from bankruptcy in 2003 virtually debt free.

What’s wrong with that? The companies haven’t figured out how to make money yet. The long-haul carrier Viatel, for example, emerged from bankruptcy in May, and it’s still trying to compete on price. This strategy is the same one that got it and the others into trouble in the first place, helping to produce 47 bankruptcies from the beginning of 2001 through this October. Bandwidth prices have fallen to such a low level that it’s hard for companies to cover expenses. From January 2001 to September 2002, prices have fallen 44 percent on average, according to Band-X, a London-based bandwidth-trading firm. And they aren’t likely to rise anytime soon, since supply still greatly exceeds demand. For instance, in the United States nearly 75 million households are cable-modem ready, but only 11 million have chosen this route for high-speed Internet access, according to a recent report by the U.S. Department of Commerce’s Office of Technology Policy.

What It Means
Get ready for more pain. According to a study by Lynn LoPucki, a professor of law at the University of California at Los Angeles Law School, 42 percent of the companies that filed for reorganization in Delaware Bankruptcy Court from January 1, 1991, to December 31, 1996, are likely to file for bankruptcy protection again. Chapter 11 protection served merely to keep telecom companies alive when they should have died. Consolidation hasn’t happened, supply hasn’t decreased, and prices haven’t risen. Companies that come out of bankruptcy will still find it difficult to boost cash flow in order to pay off debts. This will lead to reorganization–again! Expect a cycle of bankruptcies, much like those the airline industry suffered in the late ’60s and early ’70s.

On the Horizon
The chaos is an indication that the industry is changing from a highly integrated vertical business to a horizontal one with razor-thin margins (see “Baby Bellyflop”). Tom Evslin, the CEO and founder of IXTC, a voice-over-IP company based in Princeton, New Jersey, compares the recent changes in the telecom landscape to the shift from mainframe computers to PCs. In that transition, dollars came out of IBM’s pockets and into the coffers of Microsoft and Intel. Mr. Evslin predicts a similar redistribution of wealth in the telecom industry. Dollars that once went to Lucent Technologies and Nortel Networks will find their way to companies that make soft switches, voice-over-IP equipment, and replacements for expensive hardwire switches that route phone calls. It will be a painful transition. Even the most optimistic don’t expect things to settle down before 2004. For many companies, that will be too late.

(Published first in Red Herring, December 16, 2002 issue)