Like eating Jell-O with chopsticks, finding funding for startup service providers is difficult. After a few years of being viewed as hot property by the financial community, these carriers are now seen as risky businesses. That unsavory label has left the fledglings at a loss for ways to continue funding the rollout of their networks.
Enter vendor financing. The big manufacturers of telecom equipment don't want to see part of their potential market shrivel up and die, so they're leaping into the vacuum left by the capital markets and committing billions in equipment financing to these carriers.
But what’s being done to shore up cash-strapped service providers has many wondering whether today’s big equipment vendors are walking through a forest fire on wooden stilts. Indeed, the practice of vendor financing — where vendors loan service providers money to buy their own equipment — is coming under increasing scrutiny (see SEC Cracks Down on Book Cooking).
The reasons for this are many and, remarkably, the vendors doing the most lending are the least willing to talk on record about the specifics of their practice. Cisco Systems Inc. (Nasdaq: CSCO), Nortel Networks Corp. (NYSE/Toronto: NT), Lucent Technologies Inc. (NYSE: LU), and Alcatel SA (NYSE: ALA: Paris: CGEP:PA) were all approached for this article, and only Alcatel provided a qualified representative. (Not that he could reveal much, but he was a good sport.)
To be fair, the aforementioned vendors have begun addressing vendor financing issues in their quarterly earnings calls, and each assures investors that they’re conservative lenders and that the practice is no cause for alarm. (Of course, we wouldn’t be doing our jobs if we didn’t doublecheck their claims.)
And while it’s true that each vendor’s financed contracts are but a tiny percentage of their overall revenues, it’s also true that the amount of money committed to customer loans is growing quickly.
According to SEC filings and other published research, Alcatel, Cisco, Nortel, and Lucent have committed about $1.5 billion, $2.5 billion, $2.1 billion, and $7 billion, respectively, to vendor financing. It’s important to note that a commitment is only a promise; the amount of money actually drawn down, or in use, by each service provider varies. In some cases, service providers don’t use any of the funds a vendor’s committed to them.
However, the amount of financing each vendor has committed has grown considerably in the past year or so. Lucent, for instance, only had $2.3 billion in financing commitments in 1998. Last quarter that number hit $7.7 billion and now it’s down to $7 billion. Nortel’s balance sheet, too, will continue to be a weapon in its arsenal. Analysts predict its financing commitments will grow to between $3 billion and $3.5 billion in 2001.
Also increasing is the number of troubled service provider whose misfortunes underscore the ugly side of vendor financing. Before it went bankrupt, ICG Communications Inc. (Nasdaq/Neuer Markt: ICGX) had drawn down on $99.1 million of a $180 million financing commitment it had from Cisco. Cisco may never get all its money back. (see ICG's Sinking Ship and ICG's Dark Cloud).
And while equipment vendors used to fancy themselves as arms dealers supplying weapons to all combatants in the service providers’ war, the uptick in financing shows that these vendors are choosing sides. In fact, some analysts view the aggressive financing tactics of vendors as an act of desperation to win contracts and nudge their way into new markets. An example more than one analyst pointed to was Nortel’s $1 billion commitment to Aerie Networks, a greenfield carrier that only began laying fiber in October (see Nortel's $1 Billion Pipe Dream).
That said, this report will endeavor to give readers a snapshot of the practice of vendor financing, as well as some analysis of where it will lead the industry if not managed carefully.
Read the report sequentially, or click on any of the pages hyperlinked below:
What is vendor financing?
Vendor financing fills the funding void
Why vendor financing is a "win-win"
When balance sheets attack