Editor's Note: Cody Willard's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published May 6 on RealMoney.
These days, competitive local exchange carriers face too many uphill battles to survive. Yes, that's right: survive. You can forget about thriving. Investors can find a lot of other compelling investments out there (granted, few in the telecom sector) instead of wasting their time with duds like these.
For example, life still isn't getting any easier for the best-financed -- not to mention best-run -- publicly traded CLECs:
Time Warner Telecom
Allegiance reported a solid first quarter Tuesday, showing a steely focus on controlling expenses. Heck, it even came in with some rather solid sales numbers, growing revenue 6.8% sequentially in a very tough market, and for the first time in a long, long time, it showed an increase in the average revenue per user, or ARPU.
On the flip side, though, the company is beginning to bump up on its bank covenants, and worried investors are running for the hills. Allegiance will likely end up having to take a page from the
playbook and spend some of its precious cash to buy revenue, thereby avoiding any violations of the covenants. (If you'll recall, telecom service provider Level 3 has been forking over millions to buy software resellers for pennies on the revenue dollar to avoid violating its bank covenants.)
In Allegiance's case, however, it will hopefully spend the money on distressed
assets. Allegiance will likely eye cheap local-line customer bases, taking them off other bankrupt carriers' hands. Although such moves aren't exactly the best possible way for a likely bankruptcy candidate to spend its cash, it at least keeps the company from facing dilution through the violations.
I'd continue to avoid Allegiance, just as I'd steer clear of the recapitalized
. They aren't in much better shape. Though they've already gone through major recapitalizations, these stocks are still highly speculative.
Don't be tempted by Covad's healthy balance sheets. Here, the company managed to persuade its debtholders to approve a complicated restructuring. Under that plan, all debt was eliminated while existing shareholders kept a significant chunk of the company with more than $300 million on the books, which was/is supposed to provide a nice runway for Covad to get to cash-flow positive. Oh, if only being a CLEC were so easy.
At this stage, the CLECs' real problem is as much structural as anything else. Yeah, they face increasingly longer and tougher sales cycles as telecom and IT managers at the small- and medium-sized business sweet spot are fearful of entrusting their communication services to such upstarts. Every single telecom and IT manager in the world has been or knows someone who has been burned by a liquidating CLEC.
And yeah, there's this whole depressed enterprise-spending situation, too, where no company wants to spend any new money on communication services. And when was the last time a new company started in this country anyway? No start-up can get any funding anymore.
Alas, the biggest problem facing these carriers is that it's simply very, very difficult to generate real cash under the CLEC model. Critical mass is necessary, but reaching it requires a whole lot of capital, something these carriers will never again see. Plus, they're competing against the incumbents' fully depreciated assets, which taxpayers actually helped fund to begin with.
Finally, and perhaps most significantly, the government has completely begun to move away from these carriers. The House's Tauzin-Dingell bill, the Senate's new parity bill and the Federal Communications Commission's triannual review of its competitive policies are all skewed toward giving incumbents more freedom and competitors less access.
Maybe Allegiance gets from here to there without any major restructuring. Maybe Time Warner Telecom figures out how to tap more capital. Maybe Covad slows its burn rate to the tiniest of levels. No matter, as I've written before, while this sector might be tradable, it sure isn't investible. Questionable survivability is no place for hard-earned capital.
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Cody Willard is a telecom and financial analyst/consultant. He is also founder of
TelEconomics.com. Willard has co-managed $150 million in private investment funds and has headed up the research and analysis division of a venture development company. He has founded several telecom and technology companies and has managed the wholesale division of a $100 million CLEC. At time of publication, Willard had no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Willard appreciates your feedback and invites you to send it to