Jubak's Journal
Let's hope Global Crossing dies quietly
If the telecom emerges from bankruptcy intact, it could drag the entire sector into a death spiral. With its debt pared down, it could slash prices, hobbling competitors already struggling in a market with too much capacity.
Will Global Crossing be liquidated or is a bankruptcy reorganization in the company's future? This battle royal is clearly headed for the courts. What's the difference and why should you care? The outcome will tell investors a lot about how long the current recession will last.
Creditors who lent Global Crossing $14 billion are desperately trying to find an alternative to the deal currently before a bankruptcy court. The offer by two Asian telecommunications companies would pay them about four cents on every dollar they invested. One possibility: instead of selling the company intact, liquidate it by auctioning off each piece to the highest bidder.
Neither plan will do a thing for current equity investors -- they're likely to be wiped out completely.
So why is it important which side wins? Well, the result is critical if the telecommunications sector is to escape what is very dramatically called a death spiral. And the decision will help determine exactly how long the current recession will keep its grip on the business side of the economy.
Bankruptcy's failure
OK, so why could a bankruptcy reorganization that left Global Crossing pretty much intact produce a death spiral?
Think about this -- the company that came out of bankruptcy court would have all the assets, all the fiber networks and undersea cables of Global Crossing, but none of the debt. In the September 2001 quarter, Global Crossing would have saved $130 million in interest and another $60 million in dividends on its preferred stock.
That's almost $200 million, certainly not peanuts when the company's total revenue for the quarter was $800 million. Global Crossing could cut its prices by $200 million and be dead even with where it was before the bankruptcy.
Of course competitors like Level 3 (LVLT, news, msgs), Qwest (Q, news, msgs) and Williams Communications (WCG, news, msgs) still have to make their interest payments. For Williams in that same quarter, accrued interest came to $140 million on $300 million in revenue.
Keeping up with the Global Crossings
To keep up with Global Crossing's ability to reduce prices a competitor like Williams has two choices -- cut $140 million in costs or go bankrupt itself. No wonder that this week Williams announced that it was studying the bankruptcy option.
A Global Crossing that emerged from bankruptcy intact and debt-free would force so-far solvent competitors to cut costs or dump debt through bankruptcy. And each new bankruptcy would lower the prices that any company can charge in this market, pushing other companies to the wall.
Qwest wouldn't be safe, nor would WorldCom (WCOM, news, msgs), Sprint (FON, news, msgs) or AT&T (T, news, msgs). Remember that Enron shows no company is too big to fail.
Strictly speaking, this death spiral only directly affects the telecommunications service companies that compete with Global Crossing and the companies that sell equipment into the sector.
The bigger problem
But more broadly it points out a problem across the entire economy: despite the recent recession it has proven to be really hard to get rid of excess supply.
Look at the market for computer memory chips. Even though prices collapsed in 2001 to $1 per 128 megabit chip from $18, nobody wanted to be the first to call it quits. South Korea's Hynix is still hanging in despite an offer from Micron Technology (MU, news, msgs).
Most recessions are led by a collapse in consumer demand. But this recession has been led by a collapse in business spending produced by too much investment in the supply of memory chips, telecommunications equipment and fiber optic networks, to name just a few.
Consumer demand has held up pretty well in the period, which means the economy can't depend on a surge in new consumer spending to get the recovery revved up. That will depend on reducing supply. And all the evidence argues that while the economy is looking up, we've still got a long way to go before supply and demand are back in sync.
AI
