Debt-heavy telecoms won't escape the credit crunch

Spencer E. Ante
21 Oct 2008

The $1 trillion telecommunications industry has long been one of the most resilient parts of the economy. But as the financial crisis has intensified, it has recently become clear that telecom can't escape the fallout of the credit crunch.

Although most analysts believe the damage won't be nearly as bad as the last telecom bust"”when hundreds of firms went bankrupt, including giant Worldcom"”there is growing evidence that the financial crisis is going to depress the debt-heavy telecom industry. To start with, rising capital costs are likely to take a bite out of earnings. In addition, the softening economy will probably crimp demand for such telecom services as land lines, cell phones, and Internet connections. Over the last week several Wall Street analysts trimmed their 2009 earnings estimates for AT&T (T), Verizon Communications (VZ), Sprint Nextel (S), and other operators. 'Everyone is going to pay more for credit,' says Craig Moffett, a senior analyst with Sanford Bernstein who has been bearish on telecom stocks.

A telecom slowdown could ripple through the technology sector. If the operators' cash flow declines as expected, that's likely to cause them to cut back on their capital spending plans. This would hurt the primary equipment makers that supply gear to the industry, as well as those that sell to them. It would also slow down the build out of future wireless and terrestrial networks.

Idled consumers might use more services

Steve Rago, an analyst at iSuppli, expects capital expenditures on worldwide wire line networks for the second half of 2008 to decline 20% from levels that telecom carriers expected earlier this year. Analysts also predict that the growth rate of spending on wireless networks will decelerate through 2010. Such cutbacks would hit equipment makers such as Alcatel-Lucent (ALU), Nortel Networks (NT), Cisco Systems (CSCO), Juniper Networks (JNPR), and scores of smaller players. 'There is going to be significant sales weakness over the next couple of quarters,' says Ari Bensinger, an analyst with Standard& Poor's. 'A lot of these aggressive deployments are getting pushed out.'

The impact, of course, would be softened if credit markets settle down. In fact, some big telecom operators such as Verizon say they have yet to see signs of a slowdown. Rather, Verizon execs believe that a recession could lead Americans to become even greater couch potatoes, saving money by gabbing on the phone, watching TV, and surfing the Internet. 'I don't see any evidence of us slowing down,' says Verizon spokesman Eric Rabe. 'If you need to find a job, a broadband connection is pretty critical.'

But if credit remains tight, telecom carriers will surely feel some pain. After all, telecommunications is one of the most capital intensive businesses in the technology industry. It costs billions of dollars to build and buy the networks that enable people to communicate. Earlier this year, Verizon dropped $9.4 billion alone for wireless spectrum that will enable it to build an even faster mobile network.

A squeeze in commercial paper

To help pay for these investments, telecom carriers use various forms of debt, such as commercial paper, credit facilities, and corporate bonds. These work well in good times. But with the financial system in a state of panic, credit has become much more expensive"”and impossible for some companies to get.

While credit analysts believe that the carriers' huge cash flows make them solid credit risks that are highly unlikely to default, the analysts say higher borrowing costs will reduce earnings and force the carriers to scale back on their ambitious plans.

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