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Debt Weighs on Euro Carriers

Light Reading
News Analysis
Light Reading
7/24/2002

The European service provider market is still growing, but the carriers there are faced with greater debt loads and more regulatory challenges than their American counterparts, according to two recent reports on the European telecom industry.

“Europe is a bleak place, as well as North America,” says Richard Webb, the author of the Infonetics Research Inc. report, "Service Provider Networks: Access, Routing, Switching, and Optical -- Europe 2002," published two weeks ago. The report is based on April interviews with 10 out of 70 European service providers and predicts the direction the market will take over the next year (see Infonetics: Money's in Metro).

The other report, titled "The Future for the Telecom Incumbents: the Impact of Competition, Regulation and Customer Demand," was published last week by Analysys. This study addresses the situation facing the 14 European incumbent players and the possibilities for them to lay out long-term strategies while still tending to their out-of-control debt loads (see Analysys: Future Hazy for Euro Telcos).

“The incumbents are in a unique position to gain market share... [since they] are benefitting from the struggles of the newcomers,” says Tamsin Pert, the author of the Analysys study. “But, because of their debt [and regulatory pressures], they’re less free to pursue increasing their market share.”

Amidst reports yesterday that British Telecom (BT)’s (NYSE: BTY) stock price has plummeted to a 14-year low, and that Deutsche Telekom AG (NYSE: DT) has been forced to sell off €75 million worth of real estate in an attempt to reduce its €67 billion debt load (the euro is currently about equivalent to the dollar), it is obvious that service providers are hurting on both sides of the Atlantic. The studies, however, indicate that they’re not necessarily suffering from the same illnesses.

Unlike American telecoms, most of the incumbents in Europe have a large percentage government ownership. This often helps the companies mask their problems longer, and this has allowed them to drive up their debt levels to ludicrous heights -- easily dwarfing the debt load that forced WorldCom Inc. (Nasdaq: WCOME) into bankruptcy on Sunday. France Telecom SA and Deutsche Telecom’s combined debt of more than €120 billion is, for instance, about the same as that of the nation of Argentina (see Carrier Scandals: Who's Next?). The 14 incumbent telecoms covered in the Analysys study have a combined debt of €240 billion.

“There is no way businesses can get into that kind of debt without having a government behind them,” Webb says, pointing to one of the Infonetics report’s conclusions that national governments holding a significant stake in incumbents compromises a liberalized market.

While a large portion of government ownership in a company may have, in the past, helped pry open the tight grip lenders have on their purse strings, Pert says, it also adds to the regulatory pressures on the companies. She also thinks the lenient days are over. “Incumbents are unlikely to get any more leeway before they show some results from the investments that have already been made. The incumbents have to manage their debt.”

But while debt is a big issue, she says, it’s also important that the incumbent players think further ahead. Management teams have to start thinking about their companies’ future positioning and not give in to pressures to sell off unprofitable assets and units just to make a dent in an overwhelming debt load. At the same time, Pert cautions, in today’s uncertain climate, companies shouldn’t rely too heavily on one plan. “They need to avoid committing themselves too rigidly… in what is likely to remain a very uncertain industry for the next five years,” she writes in the report.

In response to the changing market conditions, the incumbents have, according to Pert, chosen approaches that fall into three different categories: the Globetrotters, which try to maintain a global strategy; the Eurovisionaries, which are going after a more defined market -- say, Scandinavia; and the Homebodies, which have decided to focus solely on their respective national markets.

The Eurovisionary approach will, according to many observers, soon be the predominant one. Webb, for instance, says he expects that the European market is moving towards a division into sub-regions. “We might end up with power houses in Scandinavia, the Mediterranean, etc.” This, he says, would certainly give service providers better stability, although it probably wouldn’t do much for consumer choice.

Despite their troubles, the European incumbents are in better shape than the new players in the market. Netherlands-based KPNQwest NV (Nasdaq/Amsterdam: KQIP), which filed for bankruptcy in May and saw its remaining employees walk away last week, leaving the network hanging, is a good example of the affect the steady stream of new competition, plummeting capacity prices, and the dominant position of the incumbents have had on the European market (see KPNQwest for a Buyer and KPNQwest Breaks Its Ebone).

"The freefall in capacity prices has claimed a number of European service providers over the past quarter, and it’s likely that several more will follow during 2002,” the Infonetics report states.

Despite all the problems plaguing the European service providers, both Pert and Webb insist that the market is still growing. Between 2002 and 2006, expenditures for optical network equipment are expected to grow 103 percent, from $3.1 billion to $6.3 billion, according to the Infonetics report. Router and switch expenditures are expected to grow 197 percent, from $1.5 billion to $4.5 billion.

The financial crunch amongst the European service providers will not lead to a complete halt in investments in new technologies, Webb says, noting that, curiously, the financial situation has led to service providers spending money on equipment that enables new service rollouts or lowered costs: “If not, they won’t spend money on it. They are certainly making vendors jump through more hoops.”

As in the U.S., Infonetics reports, the European metro market continues to be the bright spot, especially for providers that deliver additional services, like quality of service, security, voice over IP, and wireless data.

Analysys concurs that the service provider market is still growing, but cautions that critical issues surrounding demand, success of 3G, and regulation add up to a heap of uncertainty.

— Eugénie Larson, Reporter, Light Reading
http://www.lightreading.com

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