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Optical/IP

Carriers Navigate Dark Waters

Small startup CLECs (competitive local exchange carriers) were the first victims of the telecom recession. Now high-profile telecom carriers building new fiber-based data networks -- the so-called "greenfield" carriers --- are feeling the pressure of the extended slump.

A combination of weaker financial markets, poorer operating results, and higher debt levels is threatening the health of several of North America's largest carriers.

Specifically, a look at the finances of two prominent carriers, Level 3 Communications Inc. (Nasdaq: LVLT) and 360networks Inc. (Nasdaq: TSIX; Toronto: TSX.TO), shows their financial positions deteriorating.

360networks seems to be long on capacity and short on cash. "They are in a tenuous situation," says Aryeh Bourkoff, director at UBS Warburg. "They still have a lot more contracts to sign in order to meet their revenue and cash flow targets for the year."

360networks has built 21,000 miles of fiber in North America, of which 12,000 miles the company says are lit. It has built 6,200 miles in Europe and lit 3,800 miles. And the carrier's forging ahead on expansion plans for these long-haul links, even as it struggles to install 35 major metro fiber rings worldwide by mid-2001. In short, it needs lots of new customers to make good its ongoing investment.

As the company pursues an aggressive buildout schedule, however, a glance at 360networks's most recently published balance sheet (see 360networks Posts $158M Q4 Revenues) shows some unfavorable financial metrics. For the year ended December 31, 2000, the company reported a net loss of $355 million on revenues of $511 million, compared with net income of $24 million for the year 1999 on revenues of $360 million.

360networks maintains that its cash revenue and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) are robust. Cash revenue, which includes deferred sales from contract wins that will be added to final revenue figures in the future, reached $644 million for the year ended December 31, 2000, compared with $370 million for all of 1999. Adjusted EBITDA, which includes the revenue that will be deferred, rose to $255 million for the year ended December 31, 2000, an increase of 138 percent over $107 million in 1999.

But 360networks' fourth-quarter 2000 EBITDA was $10 million, down from $29 million at the same time last year. And expenditure (capex) plans for 2001 have been slashed by $500 million, to a projected $3.5 to $4 billion, and may have to come down further.

The company seems to have focused on completing its network expansion at the expense of leveraging its IP backbone with recurring service revenue. Delays associated with the capex reduction could limit the company's ability to install and activate the optical circuits in its network. In turn, this is likely to increase the carrier's reliance on non-recurring dark fiber and leased capacity sales -- not the best strategy in times when carriers need to focus on mining their existing infrastructure. In short, if 360networks can't improve its cash flow and liquidity, analysts say, it could find itself in dire straits.

"There's a question mark hanging over 360networks," says analyst Vik Grover of Kaufman Bros. LP. "They clearly have an issue around how they'll differentiate themselves and build a big company," he says.

According to Grover, however, the company still has time to cook up some alternative strategies. "They have an interesting opportunity to acquire some of the beaten-up carriers out there and maybe piece together a company, although I don't know what life form that would take," he says. At the very least, 360networks will need to refocus, analysts say, and determine how to make the most of what it's already got.

360networks says it's on the right track. "We are proceeding with our announced network plans and remain fully committed to our global strategy," a spokesperson says. "However, given the current capital markets, we are also monitoring our cash outflows very carefully to ensure the appropriate uses of capital, as well as constantly evaluating our network build versus buy decisions."

Unlevel Debt

Level 3 is in somewhat better shape, though it is by no means out of the woods. In its first-quarter financial report on April 18, the company reported cash revenues of $657 million and GAAP (generally accepted accounting principles) revenues of $385 million. (According to Level 3, communications cash revenue reflects increases in the amount of contract wins involving deferred cash, which later shows up as regular GAAP revenue over a 5- to 20-year period.)

While the growth in these figures was huge (a 297 percent increase over GAAP revenue at the same time last year), it's notable that Level 3 is issuing lower guidance for GAAP revenue than for cash revenues for 2001.

Specifically, Level 3 says it plans cash revenues for 2001 to be between $2.3 and $2.4 billion (down from $2.4 to $2.5 billion cited previously) and GAAP revenues to be $1.4 to $1.5 billion (down from earlier estimates of $1.7 billion). Analysts say Level 3 may be doing this because they see an increasing percentage of one-time, dark-fiber/capacity sales, as opposed to recurring network-based IP revenues. And that isn't good news, since it indicates the carrier's long-term prospects for recurring revenue from IP services may be less than what's expected to come from sales of dark fiber.

For its part, Level 3 says its prospects are good. "We have $4 billion in available liquidity," a spokesperson says. "We've also stated that we've shortened the time until we intend to generate more cash than we spend." Now, the company plans for that crossover to occur in 2003, not 2004.

More woes may also be brewing at Williams Communications Group (NYSE: WCG). While the company's recent financials indicate losses are narrowing and funding's improved, analysts remain concerned about the carrier's ability to keep its business running smoothly. "There's a fear that Williams will be faced with lower prices in its core business [voice transport]," says Aryeh Bourkoff. "Also, it has strength in its high-quality customer base. But that is concentrated, and losing one could affect Williams's ability to stay a going concern."

Williams says it is focused on growing a larger, more diversified customer base. Also, it notes that being a carrier wholesaler makes it less liable to the vagaries of pricing that rule the retail telecom market.

What's the bottom line? In the present challenging environment, unprofitable companies with negative cash flow, rising debt levels, and liquidity concerns are vulnerable. And while many factors are influencing the financial solidity of all the major carriers, the times demand that all firms stay alert to a variety of dangers.

Capex Carnage

The carriers, of course, are taking action to stem the losses -- which has hurt the vendors of networking equipment. This has come in the form of further reductions in capex plans for 2001 and even 2002.

After a deluge of quarterly reports from major telecommunications carriers, it’s emerged during the past few weeks that capex expenditures are still being slashed. Recent analyst feedback suggests that situation may be worsening.

For example, UBS Warburg analyst Nikos Theodosopoulos points out that carrier capex budgets tend to be come loaded into the end of the year, with 20 percent of expenditures occurring in the first quarter.

This year, the analyst estimates that roughly 25 percent of budgets were exhausted, causing him to become increasingly cautious about the future. As such, Theodosopoulos expects the downturn to persist throughout the year, and expects 2002 capex to be down roughly 7 percent from 2001.

Other analysts voice similar sentiments. Salomon Smith Barney analyst Alex Henderson looks at “best case” and “worst case” scenarios in his forecast. If the stars align correctly, spending drops 5 percent to 10 percent this year with flat to marginally positive growth in 2002. If well-funded carriers stumble and traffic growth moderates, capex levels could drop 15 percent to 20 percent in 2001 and 2002.

In reviewing the numbers, a broad trend emerges. The carriers that executed their network buildouts well (i.e., Qwest Communications International Corp. (NYSE: Q), Broadwing Communications (NYSE: BRW), Verizon Communications (NYSE: VZ) are still spending, and have given guidance for low single-digit declines for the rest of 2001.

Though aggregate capex is down, certain areas are expected to remain strong, namely metro DWDM (dense wavelength-division multiplexing), because the carriers need to generate metropolitan-based services to expand their businesses. According to most analysts, the hardest hit area of spending will be on network backbones. The big DWDM pipes are largely there, and now it’s time to fill them with IP-based, revenue-creating traffic.

- Mary Jander, Senior Editor, Light Reading http://www.lightreading.com and Chris Bulkey, special to Light Reading
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rhaley 12/4/2012 | 8:28:32 PM
re: Carriers Navigate Dark Waters As the article pointed out, metro optical equipment will be the most resistant to the "capex carnage." Our research strongly concurs. It will be more than metro DWDM, however -- next-generation, multi-service SONET equipment, optical Ethernet equipment, etc. (including gaining traction for coarse WDM in the metro).

Interestingly, we find that the metro optical space is capturing increasing strategic attention from IXCs and Internet carriers (Jander's "greenfield" carriers) -- the Level 3's, WCG's, GC's, Qwest's, etc. -- and we forecast that these carriers will dominate spending on next-generation metro optical equipment over the next five years. The question for the financial community appears to be: are these carriers "strings" long enough to allow their metro optical strategies to be significantly tested?

For more info, see the press release that hit the streets yesterday: "IXCs Set to Storm Metro Optical Networking Space"
http://www.prnewswire.com/cgi-...


Titanic Optics 12/4/2012 | 8:28:30 PM
re: Carriers Navigate Dark Waters >>Huh, 4X20 = 80. How is this front-end loaded?<<

I re-read the First Call note, and it appears that this is a miswritten, and if you read on in the article it makes sense if you make the following correction: "Typically, CAPEX is BACK-end loaded", i.e. they spend 20% in Q1, and then increase through the year to get to 100%--something like 20%, 25%, 30%, 30%. What this does is provide sequential growth (each quarter is better).

What Nikos contends happened this year is that a lot of carriers spent, say, 30% of their planned budget already, meaning that future quarters may be relatively lean. (He also includes other conjectures in this note.) Hence, he decided to lower guidance and price targets for the equipment firms.
netmaniac 12/4/2012 | 8:28:29 PM
re: Carriers Navigate Dark Waters I'll take you on...You don't have a clue what your talking about. Why do I want to manage tens of thousands of STS-1 circuits in my core transmission network? The way I see it and the way I am designing my network is 2.5G grooming in the core and STS-1 grooming at the edge. I would also contend that the CD cannot scale to the levels I need for a core machine.

Do remember, the customer is ALWAYS right and he has just spoken.
Scott Raynovich 12/4/2012 | 8:28:28 PM
re: Carriers Navigate Dark Waters yes, I've corrected it. thanks for the correction.
runner 12/4/2012 | 8:28:28 PM
re: Carriers Navigate Dark Waters As someone who works for one of the "carriers that executed their network buildouts well," I have to tell you, we're spent for the year. We're pushing jobs out as far as possible and doing no buying unless the circuit is already sold and capacity on a span is out. It's really going to hurt some suppliers bad.
optinuts 12/4/2012 | 8:28:26 PM
re: Carriers Navigate Dark Waters "Scalability - I agree that CIENA has been quiet about its strategy - but I know it has one"

will furio enlighten us if he knows what the strategy is?

i think its stack multiple boxes together and connect them with interties...a sure prescription for failure.

the competition isn't with tellium. its with the super sts-1 boxes from nortel, alcatel, and lucent.
netmaniac 12/4/2012 | 8:28:25 PM
re: Carriers Navigate Dark Waters Well, let's see...A rather large percentage of my customers are taking a direct OC48 hand-off, all of the core routers on my network are taking either a 2.5 or 10G hand-off, several other customers are asking me to look into providing them an OVPN at the 2.5G level. My point, is that for smaller carriers and wannabe global carriers, the CD may be a good fit. For a large carrier with traffic patterns like I have outlined, the CD is waaaaaaay to smal and costly.

One size does not fit all.
netmaniac 12/4/2012 | 8:28:25 PM
re: Carriers Navigate Dark Waters Furio,
I'm not advocating TELM or CIEN and am not a TELM customer, just a customer in the process of designing a optically meshed network. But from a network cost perspective, why would I want to pay the extra $$$ for a machine with an STS-1 matrix. The CIEN box is not designed for the core network or else they (you) would have made it public by now as to how they will be able to scale the CD.
oc-3072 12/4/2012 | 8:28:23 PM
re: Carriers Navigate Dark Waters Netmaniac-
So you're not a TELM shareholder, heh? I have a hard time believing that... you seem to be in constant defense of them:

------------------
Author: netmaniac Number: 7
Subject: RE: Tellium and its future Date: 5/1/2001 2:39:08 PM


iprsvp

You obviously work for one of the other switch vendors or a carrier that doesn't understand core long haul transmission networks.

"Tellium doesn't really have a grooming switch so it can't compete with CIEN." From my view, TELM and CIEN don't have competitive products but rather complimentary products. TELM works in the core of the transmission network providing protection and management at the lambda level while CIEN sits at the edge of the core grooming the STS-1s as required.

Cisco's 15900 is/was the only real competitive product to TELM and I really wish they could have held in there. The real problem, is that they are a bunch of data guys that were trying to develop a transmission product.

As to the OOO switches, I have seen a lot of sales pitches from a lot of vendors and have yet to be convinced that the OOO switch will be ready for prime time in less than 24 months. In my opinion, the vendor that comes out with an integrated OOO/OEO will be the winner. This would then allow me to remain at the optical level for pass through traffic or drop traffic into the electrical fabric that needs regeneration or convert from one optical channel to another.

You also referred to NT, what switch are you referring to? The DX? HDX? If DX, it's nothing but a beefed up ADM. If HDX, I'm from the "Show Me State."

SYCM - Can't scale beyond 64x64 and are hamstrung by components availability.

CORV - Great hype and mystique, but where's the beef?

BTW - I am not a current TELM customer and I don't accept stock options from the equipment vendors.
netmaniac 12/4/2012 | 8:28:21 PM
re: Carriers Navigate Dark Waters No, I'm not. I'm not a TELM share holder and I'm not a TELM customer. It's not a case of defending TELM, it's more a case of pointing out that the world does not revolve around STS-1 switching and OOO switching. I am simply trying to point out that jumping from an STS-1 switch to an OOO switch is not the best way to go in my opinion.
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