NEW YORK-Borrowing the vernacular of a traffic engineer, a financier compared the current capital market conditions for telecommunications companies to rush-hour congestion, but observed that the tie-up looks like it is slowly beginning to clear.
Investors still are sorting out a host of concerns that arose in 2000 about the market in general and the sector in particular. By the end of last year, as is widely known, the flight to safety was the hallmark of the capital markets. The issues, including overvaluations of publicly traded companies and gauging realistic time horizons for returns on investment, have not yet been fully resolved.
The carriers are at the head of the motorcade, and many are hoping to break out of the pack to raise large sums of money this year. Verizon, which postponed an initial public offering of its wireless business in the fall, seeks to get it to market. Cingular, the SBC-BellSouth joint venture, also plans an IPO. Deutsche Telecom plc is expected to take its wireless unit public after closing its VoiceStream Wireless Corp. and Powertel Inc. acquisitions. Royal KPN of the Netherlands and British Telecommunications also have their sights set on taking their mobile communications enterprises public.
Sprint PCS plans a secondary stock sale, as does Japan’s NTT DoCoMo, which needs capital for its overseas activities, including the large equity stake it agreed to take in AT&T Wireless Services Inc. It also is anticipated that AT&T Corp. will distribute to its existing shareholders the 80-percent stake it holds in AT&T Wireless Group.
“It all adds up to tens of billions of dollars of pure-play wireless equity entering the market,” said Bill Benton, a wireless service provider analyst for William Blair & Co., Chicago, in his “Mobility Metrics” report, published in January.
Also on this list is France Telecom’s IPO of 13 percent of its stake in United Kingdom-based Orange plc, which it acquired from Vodafone AirTouch plc. This IPO, whose shares are set to begin trading overseas Feb. 12, offers a cautionary tale. The deal was priced Jan. 22 to raise between $52 billion and $61 billion, about a 20-percent discount below the expected range.
“What is bothering the carriers is 3G (third generation services). Eventually, it will be a very good business, but it will take a while to develop and will go slower than expected to roll out. The vendors don’t yet have the capacity to build these networks, and the handsets can’t yet do 3G,” said Michael Hannon, general partner of JP Morgan Partners, New York.
“What you’re seeing in the capital markets is a lot like rush hour on the freeway when someone hits the brakes, and traffic slows down all the way back.”
Where wireless operators are concerned, there is a great deal of wishful thinking, Benton said. Underlying this is the supposition that the winners will be those who can spread their capital costs over the greatest number of customers and the expectation that capital expenses will decline over time.
Because most carriers do not generate positive cash flows, the traditional valuation metric, investors have had to make do with less reliable surrogates like raw subscriber numbers and market share. The investment community also has “not concentrated as much as it should on customer-acquisition costs,” he said.
As a result, wireless providers, more so lately than ever, have engaged in the extreme sport of “outrunning their disconnects” by offering aggressive and cheap calling plans to entice customers in market segments that are less lucrative, like prepaid. Verizon Wireless, the largest mobile operator in the country, led the latest round of price-cutting with the aggressive plans it introduced late last year, Benton said.
“I would caution that companies are making some potentially irrational moves regarding their price plans. … Grabbing market share as a means to generate a sustainable return on investment is not something that is likely to last forever,” he said.
“Wireless is a huge upfront fixed-cost business that needs a lot of customers over which to spread costs, but you can only cell split so much. … Capital spending is a big giant no one is looking at. Some analysts are talking about capital expenditures going down to a fraction of what they are. That’s a nice thought, but it won’t happen.”
Despite those caveats, Benton said he believes, as do other analysts and bankers interviewed, that wireless is “a fantastic industry with a lot of growth in it.” The sector was caught up late last year in widespread investor sentiment of fear and disappointment that closed off access to the public debt and equity markets for many kinds of companies.
“As to where capital will flow to, we still see interest from the private-equity side as we look at cellular and PCS carriers. We are primarily focused on private-equity placement for network operators. For some of the emerging carriers, as the public markets close down and they can’t take advantage of the public market, certain private equity sources are interested and we have seen some instances of venture-capital funding and other private-equity sources,” said Brad Busse, president and chief operating officer of Daniels & Associates, Denver.
“They are more careful today but still are interested in financing things that clearly are an extension to existing areas or have obvious implications for increasing cash flow, as opposed to something new that will pay off down the road.”
JP Morgan’s Hannon characterized the situation today as one of “tremendous market opportunity and a relative lack of capital in several areas.” For those who possess capital to lend or invest, 2001 will be a lucrative year, he predicted.
Public debt markets begin to thaw
Big public companies or their affiliates are regaining access to financing. The public debt markets, which are the underside of the iceberg to the tip composed of public equity, slammed shut to most applicants in all sectors late last year. However, a thaw has begun.
“The high yield markets have improved, and a lot of deals were done in the telecom space in January,” said Benton of William Blair.
These included two large debt deals of $350 million and $450 million respectively, for AT&T Wireless affiliates Triton PCS and Telecorp PCS, in which JP Morgan Partners has equity investments, Hannon said. Although network equipment makers have held back on additional financing for their carrier customers, Leap Wireless Inc. received a vendor financing commitment from Qualcomm Inc., he added.
“The vendors are increasingly worried about getting stuck with a lot of (carrier financing) paper they can’t syndicate (for resale to outside investors). The vendors’ job is not to be a bank. When the bond market dried up at the end of 2000 during a big (bond) buyers’ strike, it did so for everyone. It didn’t matter if your deal had Craig McCaw or Mike Armstrong’s name on it,” Hannon said.
“The (bond) market has begun to clear, and the vendors have begun to offload their paper. Now they want to get their (customer loan) inventories down to proper size.”
With carriers and vendors at a financing standstill, the ripple effect had impact on components makers, like smart antenna makers and providers of software to allow different kinds of connectivity for wireless devices. For this category of companies, which Hannon described as “arms merchants,” the situation is exacerbated by consolidation among wireless operators.
“Big (carrier) companies have long decision cycles, and a process is going on where small companies are running out of cash … Arms merchant companies make carriers’ lives easier by improving quality of service to end customers, increasing customer satisfaction, reducing churn and increasing the profitability of each subscriber.
“There are hundreds of these companies, and a lot aren’t going to make it. In the near term, there are a lot of companies set up based on very optimistic as
sumptions, and every one of them hopes to get 10-percent market share. There is a market-clearing mechanism going on, and some whose business plans are not correct will get consolidated or removed. But the problem is that (investor perception) has swung to the other side, that all will fail. That’s not true either.”
Like Hannon, Dwight Davis, a vice president and securities analyst for Summit Strategies, Kirkland, Wash., said he is trying to sort out the various players and their prospects for success.
“It’s a very confusing market right now. It was hyped last year, and now there are a lot of doomsayers. But there are a lot of hurdles to overcome: enough bandwidth to support high data rates; fragmentation among competing standards; so many players coming out of the woodwork with categories hard to define. Are they application development tools, hosted services? It’s hard to get below their superficial market positioning and hard to paint a clear picture of the ecosystem,” he said.
Vendor capital
Even as domestic carriers engage in aggressive pricing plans to attract large numbers of low-end customers, the sweet spot in wireless data today remains the business and enterprise customer.
“For all the reasons everyone knows, there are some big hurdles to overcome when rolling out to the mass market, which is high volume but low margin. By contrast, the business side niches have a very high payback, and it is easier in many cases to come up with a return on investment in a reasonable time frame than for the consumer market,” Davis said.
Large equipment vendors have stepped up to the plate, adding their own capital as secondary investors to traditional capital sources for smaller companies that may speed time to market for new products of benefit to wireless carriers.
“To some degree, there was a big rush by vendors to set up venture-capital funds as a replacement for R&D. This was part of the dot-com craze, partially to get a quick return on investment as valuations shot up, “Davis said.
“In this world of burst bubbles, they have become more tactical in their approach, looking for strategic plays.”
Consolidation among carriers has raised the stakes for the increasing number of companies that want to supply them with goods and services. At the same time, there also are many smaller, independent carriers, some of them still in the planning stages. Some of these newcomers plan to go after the same enterprise customers that today represent the most lucrative wireless data customers for all network operators in the United States.
These include Japan’s Mitsubishi Materials Corp., which is seeking business partners and network licenses for its Swiftcomm wireless data network technology. Securicor Wireless is another contender also backed by a deep-pocketed public parent, this one in the United Kingdom. It owns large blocks of 220 MHz spectrum and patents to the technology it has chosen to deploy for enhanced dispatch and telemetry services.
“A lot of these business plans are hopes and dreams in search of financing. They are great business plans for 1999, not for 2001, because there is not enough of an identifiable market. The market forecasts are overstated,” Hannon said when asked about these new wireless data carriers.
“Just because something is technically feasible doesn’t mean it’s financially viable. You have to identify the market, sell, service and maintain customers. All of this is incredibly difficult.”
Investors also have concerns about smaller, nonspecialized wireless carriers, said Benton of William Blair & Co.
“Small-to-midcap opportunities, companies with less than $5 billion in market cap (capitalization) are relatively scarce. The only way to play them is U.S. Cellular, Western Wireless or Rural Cellular,” he said.
“The rural cellular play was a nice story, but the whole affiliate structure AT&T and Sprint set up changed the ballgame, offering affiliates a national brand, distribution and a low cost structure. The big guys also have become very aggressive about roaming prices, and they’ll take you off their preferred roaming lists,” Benton said.
