1 perspective on the carrier market: is there light at the end of the tunnel? sureel choksi level 3...
TRANSCRIPT
1
Perspective on the Carrier Market:Is there light at the end of the tunnel?
Sureel ChoksiLevel 3 Communications
2
Life a Year Ago
3
Summary of the Past Year
4
Only a portion of the market caps of all of these companies are known from 11/00 (Level3, Global Crossing, ITC Deltacom, MFN, and Neon). Their average loss from 11/5/00 to 5/10/01 was 70%. The other companies market cap of 11/5/00 was calculated based on this average loss.
Market Value of Emerging Carriers
NEONNETWORK PLUS
ITC DELTACOM FLAG
XO 360NETWORKS
MFNGENUITY
GLOBAL CROSSING
WILLIAMSCOMMS
TIMEWARNER
KPNQWEST
BROADWING
LEVEL3
COLTTELECOM
11/5/00 5/10/01 9/28/01 10/5/01 10/17/01
$168B
$56B
$13B $11B $14B
0
50
100
150
200
Bill
ions
ofdo
llars
ITC DELTACOM NEONNETWORKFLAG TELECOM
MFNXO
WILLIAMS
TIMEWARNER TLC
LEVEL3 COMMS
COLTTELECOMGLOBAL
CROSSING
GENUITYINC A
BROADWING
KPNQWESTNV
10/17/01
$14B
0
5
10
15
Bill
ions
ofdo
llars
1-year decline from $168B to $14B
5
Wall Street’s Perspective
“It’s the end of the world as we know it”
- REM
6
Reality
“Rumors of our demise are greatly
exaggerated”
- Mark Twain
7
Today’s Agenda
What went wrong in the communications services industry?
Current state of the carrier market
Wall Street perspective
What should carriers do in this environment?
Where does Level 3 fit into all of this?
8
What Went Wrong?
The 1996 Telecom Act opened the market for competition
Investment thesis: Demand for bandwidth is unlimited Incumbents were viewed as slow-moving Improvements in optics and IP fundamentally changed
economics of communications Assets are worth at least 2-3x cost for facilities-based
carriers
Capital markets for capital intensive communications industry were free flowing Over $150 billion in capital raised by emerging
communications providers in 1999 and 2000
9
Early Signs of Trouble
Capital availability was virtually unlimited
Several “me too” business plans
Sum of companies’ projections were 2x market size
Dot-com fever spread to communications industry
Liberal interpretations of the term “fully funded”
Financial engineering by certain companies
10
Evidence of the “Me Too” Phenomenon
Europe as an example(1): 29 long haul networks constructed or partially
constructed in Europe 21 consist of swapped fiber and/or limited reach 8 are conduit-based networks Approximately 40% are financially distressed
today At least 8 are in the process of shutting down or
exiting Consolidation activity is limited to date
(1) Source: Level 3 Analysis
11
Catalysts to the Decline
A “perfect storm” of: The dot-com growth followed by implosion Slowing economy Bandwidth supply / demand imbalance Shutdown of the capital markets to newer carriers Reduced revenue projections exposed significant
funding gaps for certain companies
12
What Happened to Bandwidth Demand?
First, the bad news: Demand was “exaggerated” by emerging
carriers and dot-coms Companies were purchasing bandwidth well in
advance in anticipation of exponential growth that did not materialize
Economic downturn has reduced short-term demand
As a result, there is generally a supply / demand imbalance
13
What Happened to Bandwidth Demand?
Now, the good news: End user demand for bandwidth continues to
grow at a rapid rate Even the most bearish industry assessments
of unit growth are 60-100% per year The industry is under-investing in capacity Supply / demand imbalance is temporary
14
Affected Sectors
• Emerging fiber backbone carriers
• CLECs / DLECs / BLECs
• ISPs
• Colocation / Hosting
• LD carriers, wireless companies, RBOCs and PTTs are in a separate category
15
Chapter 11
Over 50 emerging carriers have filed Chapter 11 in the past 12 months(1), including:
360 Networks Exodus Iaxis Viatel Winstar PSINet
Most companies facing liquidation rather than a reorganization
Teligent Covad Rhythms Northpoint ICG
(1) Source: JP Morgan Securities
16
Current Wall Street Perspectives
Shaken investor confidence as a result of unexpected bankruptcies and liquidations Too much competition and too much leverage Market is unable to differentiate between winners and losers Timing of economic recovery is uncertain
The result….
17
The Dichotomy of Market Views
The market is struggling to value emerging carriers
Banks, bondholders and equity investors have widely diverging views
Level 3 capital structure:
($ in millions) Book Market Implied Value Value Firm Value
Senior Secured Bank Debt 1,125$ 788$ 788$ High Yield and Other Debt 3,710$ 1,591$ 2,716$ Subordinated Debt 1,365$ 369$ 5,204$
Total Debt 6,200$ 2,747$
Common Stock 1,724$ 7,924$
10x difference!
18
What are Carriers Doing in This Difficult Environment?
Scaled back business plans Back to basics
Focusing on sales to customers that can pay their bills Differentiate through operational capabilities, not
pricing Reducing expenses to weather the storm
SG&A Capital Expenditures
Selling non-core assets Restructuring the balance sheet Consolidation?
19
Capital Spending Projections
A recent Bernstein Research report provided capital spending projections.
Carrier Capital Spending
0
20
40
60
80
100
120
1999 2000 2001E 2002E
ILECs / LECs New Long Distance Backbones CLECs ISPs / Hosting
40% Total Growth
16% Growth
-14% Growth
-16% Growth
121% Growth
-45% Growth
-29% Growth
33%
-38%
-60%
-27% Total Growth
-22% Total Growth
20
What Role will Consolidation Play?
“Elimination” will outpace consolidation
Most distressed companies will be forced to liquidate at 5 to 20 cents on the dollar
Acquisitions will be focused on acquiring valuable customer relationships, as opposed to network assets
Major industry consolidation would require restructurings High yield 101% change of control provisions would have to
be waived
21
There is Good News…
There will be fewer competitors
Those that survive will prosper
The economy will improve
The supply demand imbalance is temporary
22
What Factors Will Determine Who Survives and Prospers?
Realism
Liquidity
Ability to restructure balance sheet to create value
Ability to generate cash flow (versus revenue growth)
Focus on areas of competitive advantage
Operational capability
23
Why Level 3 is Well Positioned
See previous slide!