A cash crunch threatens to chill the red-hot optical networking sector.
Williams Communications (WCG Quote - Cramer on WCG - Stock Picks), a leading builder of the next-generation telecom networks that accommodate Internet growth, is about $1 billion short of funding for the next leg of its multibillion-dollar network expansion. To cover that shortfall, Williams is taking the unusual step of selling most of its stakes in networking start-ups that count on it as a big customer.
The squeeze isn't dire for Williams, as the company also could tap credit lines or return to the junk-bond market to raise capital. But the Tulsa, Okla., company's shortfall marks the first sign that money is tightening for the telecom-service providers that invest huge sums to build new networks. Network builders have depended on stock appreciation to fund their past buildouts. But with their stocks well off their highs, a spending pullback looms. Given the huge networking bets investors have made amid runaway demand for this gear, any cutbacks will surely sting networkers' stock even further.
This will have investors closely watching the bandwidth brigade -- network operators such as
360Networks (TSIX Quote - Cramer on TSIX - Stock Picks),
Global Crossing (GBLX Quote - Cramer on GBLX - Stock Picks),
Level 3 (LVLT Quote - Cramer on LVLT - Stock Picks) and
Broadwing (BRW Quote - Cramer on BRW - Stock Picks) -- for any signs of shortfalls like Williams'.
The Missing Link
Talk to investors and you hear more than a little concern about the prospect of a weak link in this tight chain of network builders and the companies that make networks run. With start-up networkers such as
Sycamore (SCMR Quote - Cramer on SCMR - Stock Picks),
ONI (ONIS Quote - Cramer on ONIS - Stock Picks) and
Corvis (CORV Quote - Cramer on CORV - Stock Picks) generating little revenue yet valued in the tens of billions of dollars, investors could be expected to react sharply to any sense of a slowdown.
Past the Peak
Williams returns to IPO levels. |
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| Source: BigCharts |
"My biggest concern is that we have 45% of our portfolio exposed to carrier spending one way or another, whether it's boxes or chips or contract manufacturing," says Rob McCormick, a principal at
Integral Capital Partners. "So if these guys run out of money, we are all in trouble." McCormick's firm is one of Sycamore's largest shareholders and also holds ONI and Corvis.
"There is a lot of circularity to all this," says a New York hedge fund manager who asked not to be identified. "If one thing breaks, it begins to impact other places in the chain. The key to all this is access to the capital markets."
Back on the Chain Gang
It's no secret that carrier spending -- the money telcos pay for new equipment -- is the engine that drives the networking industry. New equipment spending in North America is expected to reach $115 billion this year, a nearly 38% increase over last year, according to
Credit Suisse First Boston.
Slumping
Bandwidth bunch off its highs. |
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The networkers' story is compelling, with all the qualities the Street craves: An impossibly complex technology with a scarcity of talented engineers to make it work, reducing competitive pressure to cut prices.
What they turn out is in demand. Essentially, it's cheaper boxes able to handle phenomenally greater traffic that help reduce the cost of running networks by at least half and sometimes by a factor of 10.
New phone companies eat this stuff up, and old phone companies are building entirely new networks with this gear to stay competitive. It's not unlike watching the PC movement eclipse the typewriter era.
Tellium, for example, a company
TheStreet.com examined last week, says four equipment racks of its optical-switching equipment can replace 50 to 80 racks of traditional gear.
Unchain My Heart
To be sure, many industry observers and analysts downplay the anecdotal evidence that phone and Internet service providers are running into troubles finding financing. The players themselves brush off suggestions of a slowdown.
Level 3 says its network expansion budget is fully funded and that it has $8 billion in cash and credit available. Broadwing says it is also fully funded: It has $800 million in available credit along with nearly $1 billion in investments in Corvis and ONI that it could sell to raise cash. ONI says demand seems to be strong. The San Jose, Calif.-based maker of "metro" optical-networking gear, which is used at the edge of the Internet backbone, points to its first two sales contracts -- received this month -- to support that claim.
Unfazed
Sycamore and Ciena race ahead. |
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| Source: BigCharts |
Global Crossing and 360Networks weren't immediately available to comment. Nor were the networkers Corvis, Sycamore and Ciena.
Leadfoot
But ultimately, the question in this sector is: How long can the spending keep accelerating?
"It keeps ratcheting up, up, up, but it is hard to imagine it will keep ratcheting up forever, especially off a $100 billion base," says McCormick. "The biggest risk to the entire sector is that Wall Street freezes for even a couple months. And then we'll start to panic about where the money's going to come from to buy this equipment and whether [the telco operators] can continue their wonderful spending habits."
"These network start-ups are told by bankers that they have to be first to market, so they go on a mad rush to buy the equipment so they can sell the services," explains the New York hedge-fund manager, who has no positions in Williams or any of the companies Williams hold stakes in. "But it all is dependent on financing because they are not generating enough cash. And clearly, the stock is trading with huge growth expectations, but if they ever lost that currency, they'd be toast."
The Lemon Song
Illustrating the financing squeeze, Williams says it will lay out some $5.8 billion on new equipment and new facilities this year and next. Most of that budget has been funded; earlier this month the company completed a $1 billion junk bond offering. But it told analysts this summer it needed $1 billion more to be fully funded, though a spokesman says the figure may now be closer to $800 million.
In an effort to close that gap, Williams has sold stock it owned, including that of
Nasdaq highflier Sycamore. It also holds ONI and Corvis, though it hasn't sold any of those stakes.
The shortfall points out one of the real weaknesses in this boom: With $2.7 billion in annual sales, cash-flow-negative Williams doesn't generate enough money to cover its spending. The company doesn't expect to have positive cash flow until 2002, and with its stock well off its highs and the proceeds of a recent junk-bond offering tapped, its options were limited.
The Afterglow
Chief Financial Officer Scott Schubert stresses that the company wasn't strapped, pointing to its $1.5 billion credit line. It could sell portions of its fiber-optic network or try a secondary stock offering. But with the stock price hovering around the IPO level, neither of those options appears attractive. And Schubert notes that Williams was forced to pay a percentage point more in interest this year than last on its recent junk bond offering.
"Clearly the glow of the emerging technology companies in this space and others is not nearly as bright as it was," says Schubert. "In general, there is a tightening of the market."
And therein lies the fundamental problem. As doomsayers are apt to point out, if the public market isn't supportive, and the stock price tumbles, the center will not hold.
Scott Moritz
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