Glut in Bandwidth Threatens Future of Some Fiber-Optic Firms

Of all the tech sectors caught in the current market meltdown, few have been hit harder than the fiber-optic business. Shares of companies building undersea or cross-town cable networks, such as Global Crossing, Level 3 Communications and 360networks, have plunged 70% over the last year.

The problem: So many companies dived into the fast-growing market that there’s now far more bandwidth on the main Internet traffic routes than customers need. The result: Prices are plummeting as the carriers scrabble for cash to pay off tens of billions of dollars in debt.

“Given that we could count 50 backbone carriers, at least one-third of that capacity should not really have come into the world,” said analyst Tod Jacobs of J.P. Morgan. “This is a result of Wall Street’s excessive falling in love with that sector.”

And the worst is yet to come. Suffering under a heavy debt load, some of last year’s fiber-optic darlings are unlikely to see 2003, analysts said.

Among the former highfliers are Global Crossing, the pioneering company run from Beverly Hills; Level 3 of Broomfield, Colo.; and 360networks, a Canadian company run by ex-Microsoft Chief Financial Officer Greg Maffei.

All three have sold shares to the public since 1998 and raised billions through poorly rated bonds. The combined market value of the companies has plunged by $104 billion, or more than 85%, to $18 billion in two years. That lost value is more than AT&T; Corp. and Sprint Inc. are worth together.

The woes of those firms and others vary in severity and in the details. But everyone from tiny start-ups wiring just one city to AT&T; and WorldCom, which have their own major fiber networks, has been caught by the glut and by the intense competition over prices.

The economic rules for fiber-optic companies are similar to those for the airlines, which spend heavily for planes and then cut prices as needed to fill every seat. But the airlines can move planes from an overcrowded route to one less traveled, whereas fiber-optic cables must stay where they are.

“We have too many carriers that are trying to fill up their networks with undifferentiated products,” Jacobs said. “The natural thing to do is to lower your prices as much as necessary to lure the customer.”

The result is that even when demand grows, prices don’t go up.

“You’ve got a market where revenues are flat at best, but perhaps down. It’s not a sustainable business,” said telecommunications analyst Susan Kalla of Trade.com, who expects combined voice, data and wholesale transmission rates to fall by at least 35% both this year and next.

Even fiber-optic component firms have been hard hit. JDS Uniphase Corp., based in San Jose, is slashing 3,000 jobs, and its stock has tumbled 67% this year. Corning Inc., a major supplier of optical fiber, has cut its profit estimates and its stock has slumped 64% this year.

The companies are responding to the crisis in different ways.

Some, such as 360, have scaled back their building plans. Others are trying to integrate local voice calls or consumer long-distance businesses.

Several big players, including Global Crossing, are working to combine sales of space on their networks with Web site hosting or other data-management services.

“We see our competition as the AT&Ts; and WorldComs, because they are in the business of providing voice and data services to large corporate customers,” said Global Crossing Chief Executive Tom Casey.

The company has a long way to go to get out of the bandwidth-commodity business. Of its $5.3 billion in revenue last quarter, only $1.6 billion came from sales to businesses. Most of the rest came from bandwidth sales to competing carriers such as AT&T; and WorldCom.

Analysts said Global Crossing is in a better position to survive than many of its peers. That’s because it raised bond money early and at cheaper rates, and because it has enough money to complete its 101,000-mile network this year.

But even Global Crossing is years away from turning a profit, having lost $1.8 billion from continuing operations last year. Its annual securities filing this week acknowledged that prospects for generating enough cash to repay its $14-billion debt depend on “a number of factors, many of which are beyond our control.”

Among those factors are the price wars and how fast demand will continue to increase as the economy stumbles.

The level of future demand is hotly debated in the industry. Depending on the region of the world, many major Wall Street brokerages say the appetite for bandwidth will grow between 50% and 100% annually for years to come.

But if prices were constant, worldwide data-transmission demand would increase only 20%, said Rohit Chopra, an analyst with Deutsche Banc Alex. Brown. Kalla surveyed executives at businesses and found that they aren’t planning to spend any more for telecommunications than they do now.

Some big fiber-optic companies have been counting on a boost from new data-intensive functions, especially streaming video. Global Crossing’s Casey, for example, argues that as companies reduce their travel budgets, online video-conferencing will grow.

But high-speed consumer connections remain rare, and Kalla’s survey found that companies don’t expect to use more streaming video for three years. That will be too late for at least some of today’s fiber-optic firms and their restless investors, analysts said.

“We are extremely cautious on the long-haul industry,” said Aryeh Bourkoff, senior analyst at UBS Warburg in Stamford, Conn. “This year there shouldn’t be many defaults, but there will be some actual bankruptcy filings in 2002 if the capital markets do not improve.”

And struggling companies might not be rescued through acquisitions, because no one is in a buying mood. The traditional big carriers would just as soon see the upstarts fail, the newcomers are already too debt-laden, and the regional Baby Bells, like Verizon Communications Inc. and Pacific Bell parent SBC Communications Inc., appear reluctant to divert the cash coming in from their local-call operations.

But one way or another, the bloated number of fiber-optic cable miles will wind up being run by fewer companies, Kalla said. “There’s obviously going to be enormous restructuring, and it’s likely that the prices are going to be fire-sale prices.”