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Interesting insight on the Telecom industry’s “promise of tomorrow”. We gotta eat today.



Time is running out for WorldCom

Sooner or later, company will almost certainly face liquidation


Feb. 1 ‹ There¹s been a lot of talk lately that the economy has turned the corner and that it will be pulling into the passing lane by spring. That may be true, but it is hard to see how we¹re really going to enjoy much more than a sub-par recovery until the last of the excesses are worked off the telecom space, and net new business spending can begin again.

 IN THAT SENSE, the crumbling stock prices throughout the telecom sector are actually good news. They show that investors are waking up to reality, and that instead of valuing this sector on the basis of its earnings capacity, they are now beginning to view the space as essentially a write-off, and are increasingly pricing the stocks in it on the basis of little more than the meltdown value of their balance sheets.

       That¹s something to bear in mind when WorldCom, Inc., the Clinton, Miss. communications conglomerate, releases its quarterly and full year earnings numbers next week. More than 20 Wall Street analysts follow the stock, and they¹re looking for a 26-percent decline in fourth-quarter earnings, to 18 cents per share. But they¹re not looking at what the market as a whole is looking at: a business that simply can¹t turn a profit on a cash-flow basis, and will sooner or later almost certainly face liquidation.         SECTOR SITUATION HORRID

       Yet before getting into any of that, let¹s first step back for a quick overview of the trouble in the sector as a whole. Simply put, the situation is horrid. Thanks to a decade of wild-eyed thinking about the future and vague but compelling talk of the ³wired world² of tomorrow, we¹ve transformed a large section of the U.S. economy into something that literally can¹t turn a profit.

       Ground Zero has become the telecommunications space, which thanks to all this has long since ceased being simply the nation¹s phone companies. Now the telecommunications space is, in a sense, the entire U.S. economy.

       Communications of one sort or another have become the engine driving defense spending. They are the revenue driver for much of the transportation sector. They are where the money is going in the computer and semiconductor industries. Communications spending is at the heart of the financial services sector, the utilities sector, the construction industry. Communications are literally all there is to the networking sector. They are why the fiber optics business even exists.

     It was, in short, the infinite promise of America¹s digital future, conjured by seers like George Gilder and Nicholas Necroponte, that drove capital spending in the 1990s, reshaping the U.S. economy from a world of tangible value into one of virtual opportunity. We wound up building the greatest field of dreams in the history of world capitalism, and alas, no one showed up to play.

       You remember the phrase ³see-through office buildings² that came into vogue in the S&L crisis and the real estate bust of twenty years ago? Well, that¹s what we have now ‹ at least in terms of the telecommunications space: a see-through economy.

       There are many ways to measure it, but the easiest and most meaningful for this capital-intensive sector of the economy, is the return that the companies in it now earn on their invested capital. And the best way to measure that is not to look at earnings, which really mean very little, or even at cash flow from operations ‹ which also mean little in capital intensive businesses.

       Instead, one needs to focus cash flow from operations minus the cash that has to be reinvested back in the business. If a business can¹t generate positive cash numbers by its own internal operations, and has to get the money from elsewhere ‹ which is to say, from Wall Street ‹ then the business is really is little more than a charity case, and over the fullness of one or two business cycles its financial underpinnings will drop away.

That is the problem facing the telecom space now, because its return on invested capital is, basically speaking, bupkis ‹ the most vivid example of which is WorldCom, Inc., one of the biggest house of cards ever erected by the financial engineers of Wall Street.

       Over the last 19 years, investors have poured more than $100 billion into this rural Mississippi telephone company, and basically, Worldcom has done nothing with the money except buy other phone companies. As a result, the company now sits, as of Sept. 30, 2001, with worthless goodwill on its balance sheet totaling more than $50 billion ‹ so far as I am aware, the biggest such mountain of fake assets in all of corporate America. Add to that some $30 billion of long-term debt, plus $10 billion of unpaid bills and other short-term obligations, and you¹ve pretty much got the whole WorldCom financial picture.

       And here¹s the really interesting thing: Over the course of the 1990s, this $100 billion Mont Blanc of waste has not been able to generate a single dime of net new cash for the business, with all free cash flow coming from stock sales and debt financings (the ³cash Flows From Investing² part of the company¹s financials). In other words, the second largest telecommunications carrier in the country hasn¹t actually been a sound business from Day One, but has only seemed to be so because the economy was growing and stock prices were rising.

       Now, investors in WorldCom stock are discovering the shocking truth that this entire business is no longer being valued on its ³growth story,² but rather, on a modest multiple of the tangible assets on its balance sheet.

       With roughly 3 billion shares outstanding, and tangible net worth of less than $8 billion, the whole company has a meltdown value of not much more than $2.50 per share, which is why WorldCom¹s stock price has fallen from $50 per share at the peak of the tech bubble, to a current price of less than $10 ‹ even though the company actually swung into the black in 1998 on an income basis.

       Simply put, investors no longer care about accrual earnings. The want instead to see companies that can stand on its own and generate cash by itself at the trough of a business cycle. There are almost no such companies in the telecom space, and one by one the losers are being taken out and shot. Two weeks ago we had Global Crossing. Sooner or later it will be the turn of WorldCom as well. It is the way Wall Street works.