Winstar Communications

(WCII)

says it is so close to completing its network and achieving cash-flow breakeven that it can practically smell it. But some noses on Wall Street are smelling something distinctly less pleasant.

In Tuesday's bullish

fourth-quarter earnings report, the local phone and data service provider said it has enough cash to get through the year. But considering the unfriendliness of the debt and equity markets and recent market chatter about funding worries, Winstar's outlook is far from rosy, some observers say. Now, with big telecom gear makers like

Lucent

(LU)

and

Cisco

(CSCO) - Get Report

increasingly appearing to be the last salvation of capital-intensive network builders like Winstar, shareholders of those networking giants may find themselves increasingly uncomfortable as well.

Winstar shares rallied $1.31, or 11%, Tuesday to $13.12. Amid a sharp downdraft in the telecom-equipment sector, Lucent dropped 48 cents to $12.11 and Cisco slipped $2.06 to $24.

Hungry Like the Wolf

Like many aggressive local phone upstarts, such as

Teligent

(TGNT)

and

XO

(XOXO)

, Winstar required enormous upfront investments to build networks that wouldn't see returns for years. In a bull market, those enterprises found support in the form of willing bond buyers and trigger-happy tech stock junkies. But with cash drying up as the economy decelerates and the

Nasdaq

continuing to crumble, raising money has grown much tougher and funding needs haven't abated.

Just how expensive is this business? Winstar lost $1 billion on $759 million in sales last year. And now, with $3.6 billion of debt on its books and the high-yield debt market seemingly off-limits, Winstar is rushing to use what looks to be its last line of credit: financing from suppliers Lucent and Cisco.

"Since their business does not generate any money and the capital markets are kind of shut on them, they are left begging to their vendors," says one Wall Street debt analyst who asked not to be identified. Winstar is a credit risk no matter who gives it money, says the analyst.

As cash has grown short and the capital markets have shriveled, it has become clear that vendors would have to

take up some of the slack in funding cash-strapped customers. But both Lucent and Cisco are seeing dramatic declines in their own businesses, which limits how far they are willing to go with the likes of Winstar.

Back and Forth

In October 1998, Lucent committed $2 billion in financing to Winstar, half of which Winstar can draw at any time. Currently the company has drawn down $600 million.

Lucent's financing deal with Winstar was one of the largest such deals, and the perceived risk of the deal has become a thorn in Lucent's side as the fortunes of the competitive local exchange carriers have declined. Meanwhile, Winstar's chairman and chief executive, William Rouhana, has been vocal about a perceived lack of respect from Lucent, considering Winstar is one of Lucent's biggest customers.

These rising tensions probably helped fuel recent persistent rumors that Winstar had defaulted on its loan payments. Winstar executives denied that charge on their earnings conference call Tuesday, saying they used $200 million from an earlier refinancing to pay Lucent. According to Winstar, that payment means that $400 million in additional financing will become available from Lucent.

Lucent wouldn't confirm or deny this claim, saying it doesn't comment on financing deals.

Winstar says it also has an additional $250 million in financing available from Cisco, but Cisco's love is also conditional. Cisco last November agreed to provide Winstar with $500 million -- none of which has been drawn down -- but it lent just half upfront while requiring Winstar to raise $2 by selling stock for every dollar Cisco will finance. With Winstar just above its 52-week low and some 80% below its high of last March, the market's appetite for more shares is likely to be weak.

The Other Options

Clearly Winstar is feeling the pressure. The company said Tuesday that, in an effort to reach cash-flow positive in the second quarter, it would cut 2001 capital spending by $200 million, or 10%. In doing so Winstar joins a long rank of telecom companies cutting back on their buying plans.

The company adds that it can raise cash in other ways, including strategic partnerships with long-distance phone companies and sales of network access to operators like

Williams Communications

(WCG) - Get Report

. But as observers point out, those opportunities are likely to be limited as telecom companies large and small grapple with their own funding issues. Illustrating the difficulty of raising cash in a bear market for telecom issues, just last quarter Winstar took the unusual route of raising cash by selling receivables.

"Winstar is headed for a major restructuring and the vendors, banks and high-yield folks are going to be left holding this," says one East Coast hedge fund manager who is short the stock. "No one is going to take on their debt, pay $1.8 billion plus a premium for their preferred equity, and then face a couple billion-dollar funding gap to get the company to cash-flow break-even."

Of course, Winstar sees its situation quite differently. The company points out that it has taken turf from the local Bell telephone companies by creating crucial "last mile" connections to businesses. Winstar has built its network to 4,400 buildings and expects to more than double that this year.

"What we have the most of -- direct fiber and fixed wireless connections to businesses -- is exactly what the industry has the least of," Winstar's Rouhana said on Tuesday's call. "And that's a good place to be."

But others see Winstar in a less flattering light. "This is just the prelude to bankruptcy," says the debt analyst. "A sad state of affairs for a proud firm."