The dot-com crash has been widely written up, and everybody agrees that we were all foolish to have invested in companies with no track record and no operations. But the euphoria of 1999-2000 may yet leave us with bigger casualties than mere dot-coms.
As euphoric as the wildest 26-year-old dot-com CEOs, Big Telecom, particularly in Europe, spent like there was no tomorrow, and seems quite likely to pay the ultimate penalty.
We’re not talking obscure companies here. The three most likely casualties, it appears, are British Telecom, France Telecom, and Deutsche Telekom, formerly the national telecom monopolies of Britain, France and Germany. As a trio, in Europe, they represent Big Telecom par excellence. While some large U.S. telecom companies — one thinks particularly of WorldCom — may also disappear, these three former monopolies, because of their huge stockholder base and “widows and orphans” reputations for solidity, would if they failed cause a particularly onerous blow to world economic confidence. Yet if we have a substantial, worldwide recession, their failure is not unlikely.
An interesting collateral question is whether their failure was genetically determined, as it were, by each having been for decades a state telephone monopoly linked to the post office. To determine this, it is instructive to compare their situation with that of Vodafone PLC, a company in the same business, equally active in the last couple of years, but whose corporate ancestry is completely different, since it was a 1991 spin-off from Racal Electronics, one of the most successful and best run British companies of the 1970’s and 1980’s.
If Vodafone’s position is similar to that of Big Telecom, then the difficulties are those of the market and may well be overcome as there’s no question that cellular telephony is not going to go away. If on the other hand Vodafone is in substantially better shape than Big Telecom, then Big Telecom may be doomed by its genetic inheritance of ossified state-run management, and is likely to run into severe difficulties as its businesses are eaten away by more effective competitors.
Looking at the benchmark first, Vodafone in April 2000 acquired Mannesmann, owner of the German market leading mobile telephone company. Thus Vodafone was clearly buying at the top of the market, like the other companies. But Vodafone, which was highly rated by the market, was able to carry out this acquisition for stock, thus avoiding putting huge amounts of debt on its balance sheet. Hence, when values dropped, Vodafone did not become automatically more leveraged.
As a condition of acquiring Mannesmann, Vodafone was compelled to sell Orange, its third-ranked British mobile telephone operation (Vodafone is itself ranked No. 1 with a 58 percent market share) which it sold to France Telecom for a total proceeds in cash and notes of approximately $34 billion. Vodafone competed for and won British and German mobile telephone licenses, as well as some minor ones, which will involve a cash outlay, and formed a U.S. joint venture with Bell Atlantic, Verizon Wireless, of which it owns 45 percent, which has a customer base of 26 million.
Thus Vodafone during the period of maximum overvaluation, say September 1999 — September 2000, did a lot of deals but increased its net debt from $14 billion to $29 billion, compared with tangible net worth of $60 billion; Interest cover, excluding amortization of goodwill, was approximately three times. Amortization of goodwill may well cause the group to show book losses, therefore — that’s what you get, under conventional accounting, if you buy an overvalued company using inflated stock.
But in the real world Vodafone’s cash flow position looks pretty solid and recession-proof, provided they don’t go on further acquisition sprees. This is reflected in the stock price, which at $29.5 today is 52 percent down from the high, having held up relatively well in the telecoms bear market.
Deutsche Telekom also participated successfully in the British and German 3G auctions. During 2000, it added $16 billion of debt, to end the year with $54.3 billion of debt, against tangible net worth of approximately $20 billion. In addition, the $31.7 billion acquisition of the US mobile telephone company Voicestream was still pending on Dec. 31. Unlike Vodafone’s acquisitions, Deutsche Telekom’s, also negotiated at the top of the market, were made for cash.
Net Income of $6.7 billion benefited from approximately $7.9 billion of gains from asset sales and partial subsidiary flotations, thus at the operating level the company appears to have made a loss after the $1.9 billion amortization of goodwill and licenses In any case, interest expense, at approximately $2.6 billion, was well less than twice covered on a recurring income basis.
Thus Deutsche Telekom, in very much the same businesses as Vodafone, has leverage of 2.7 times instead of 0.5 times, and debt interest well over the twice covered level that is considered the minimum required for safety in a recession. Like Vodafone, Deutsche Telekom must still invest billions for its 3G licenses. Unlike Vodafone, it is difficult to see from where it is going to get the money to do so. Its stock price at $23 is 76 percent down from its high.
France Telecom bought Orange from Vodafone, paying essentially cash, albeit part of it not till 2003, and was also a successful participant in British, German and French 3G spectrum auctions. The company’s debt rose from $13.1 billion in 1999 to $55 billion in 2000, compared with tangible net worth of approximately MINUS $17 billion.
Leverage at the end of 2000 was thus infinite. While debt interest cover before intangible amortization was a reasonably healthy 2.2 times, interest charges will be very much increased in 2001 because of the increased debt.
France Telecom expected to solve its financing problem by the flotation of its shareholding in Orange, acquired form Vodafone, but that February 2001 flotation was relatively unsuccessful, and does not cover the remaining payment to Vodafone due under the Orange sale. Hence France Telecom must be vulnerable to even the slightest slowdown in its operations. At $57.5, the stock is down 72 percent from its high.
British Telecom, another successful participant in the British and German 3G auctions, manages, like Deutsche Telekom, to be second to Vodafone in mobile communications even in its home market. BT’s profits had shown no growth in the five years to March 2000, a spectacular failing in the telecoms bull market of those years. It tried to get in the U.S. market by buying MCI, but was outbid after a merger was agreed by the upstart WorldCom, a much smaller company. Fueled by the 2000 acquisition of the German mobile telephone company Viag Interkom, BT’s net debt at Mach 2001 totaled approximately $43 billion, up from $17 billion the previous year, compared to tangible net worth of no more than $3 billion, while interest cover from operations in 2000-2001 was approximately 1.5 times.
British Telecom recently announced a restructuring, under which it intends to spin off its international directories and e-commerce subsidiary yell. Like other restructurings announced by Big Telecom, this relies on a bullish telecom/Internet equity market that is no longer there, while the cash flow drain from 3G license infrastructure construction will not go away. Hence, like the other two Big Telecom companies, BT will be lucky indeed to survive a major downturn in its industry. At $75, the stock is down 69 percent from its high, having held up somewhat better than France Telecom and Deutsche Telekom.
All three Big Telecom companies are in trouble, trouble that is qualitatively different from that of Vodafone, a competitor in the same segments of the same businesses. Hence, absent major assistance from their national governments, all three are likely to get into life-threatening difficulties when faced with nimbler, cleverer competition.
Big Telecom is threatened with extinction. The only question is, when?
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.