Family investor. Thanks for your thoughts on product development and for letting me know about the shares. Read what they say in about the fifth paragraph about the last mile. What alot of you have been saying and this author agrees with you all. Great article.
Surviving the Fall
Dot-bomb winter may lead to stronger, saner market
By Karen Brown
from the March 5, 2001 issue of Broadband Week
Oh, the agony.
With broadband startups shutting down, investors fleeing anything with a dot-com name and rose-colored glasses replaced by pink slips, this has been one heck of a Winter of Discontent for the once-golden broadband and telecommunications industry.
Success stories are endangered species on the Internet news wires these days, with forlorn earnings outlooks, reductions in capital spending, waves of layoffs and the government in the form of Alan Greenspan predicting the economic slowdown hasn't yet hit its trough.
Have we reached the bottom yet--the point of maximum pessimism--or is there still more misery in store? While it depends on who's talking, many experts are concluding the same thing--this supposed new Internet economy is acting suspiciously like the old one. With tried and true business sense re-emerging, the bust may be the best thing to happen to the industry long-term, they say.
But it won't be easy.
"It can and should get worse before it gets better," argues Doug Shapiro, a broadband analyst for Banc of America Securities LLC.
He points to two factors. First, there is a supply discontinuity in broadband network systems, with backbone capacity built out but last-mile connections remaining undersized. "The network is like a big chain and it can only hoist as much as the weakest link," Shapiro says. "As long as the last mile remains weak it is going to decelerate the chain."
Second, a lot of sectors simply were overfunded, he says. Buoyed by the giddy Internet craze in 1999 and early 2000, investment money flowed in--particularly to competitive LECs--with little examination of the underlying business plans. "Any moron who could put pen to paper could get a million dollars," Shapiro says sourly.
With investors now wising up, these poorly planned businesses are not getting funding to continue and are dying out. But there still are a number of these ailing companies that haven't yet breathed their last. "It's a natural cycle of overcapitalization followed by shakeout," Shapiro says. "Once that is done you will have some stronger companies that will survive. But it is a long way from being finished."
Time is indeed a factor, according to Shane Greenstein, associate professor of management and strategy at Northwestern University's Kellogg Graduate School of Management. He says recent Federal Reserve moves to lower interest rates and stimulate the overall economy may help matters, but it will take a good six months to see it in the market.
Even then, the industry is plagued by venture capital wariness, and investment in Internet-related companies "is going to be flat on a protracted basis for the foreseeable future," Greenstein predicts. As for equipment, "there is no way we are going to see the same demand as two years ago. But there's no way we are going to go lower."
Ken Goldstein, an economist for the Conference Board, believes this downturn is a natural market equilibrium process--and is nothing to panic about.
"Part of what you are seeing, in addition to everything else, is just simply a market trying to find what are people comfortable with," he says. "To that extent I think the wobbling--it's not necessarily the decline--but the wobbling is probably going to go on for a while."
As evidence, Goldstein points to the average price-to-earnings ratio of corporate stocks. "A PE ratio of 12 to 15 was about standard," Goldstein says. "Then all of a sudden they went up into the 15 to 20 range and then the 20 to 25 range and they got all the way up to 36 in the summer of 1999. They have sort of come back down to 25.
"The question is, where are we going? Not in terms of anything else but just what's a quote 'normal' ratio these days? Is it going to go back to 36? Probably not. Is it ever going to go back to 10 or 15? No."
For KPMG LLC optical and network equipment expert Ed Rodriguez, the gloom also is likely more of a blip than a long-term blight.
"Obviously, we are going through a bit of an unsettling time right now, and I think it's not just limited to the communications sector. How long that will continue--I frankly, not withstanding some of the recent press that's been out there, would be surprised if it goes much beyond the end of the summer," he says. "If you just step back from it all, this is just the very beginning of what I think is going to continue to be an explosion in the overall evolution of the Internet infrastructure."
But the mounting attention to the slowdown may indeed have an impact, Rodriguez acknowledges. "It's pretty clear that when you've got the big carriers cutting back which have such a significant impact on the entire industry and when you see what's happened with the dot-coms, there's nervousness out there. People are concerned, and they are saying 'Wait a minute. Let's hold off here,'" he says. "There is just a lot of noise in the system that has got everyone concerned and what that's probably going to do is add at least a quarter to what might have been a quicker recovery."
Even among the affected businesses there is concern but not panic. Internet equipment giant Cisco Systems Inc. is among the businesses feeling that economic pain as network operators scale back on their gear orders. Larry Lang, vice president of the service provider market business, says it is a predictable hangover caused by the market over exuberance in 1999, but it is not a reason to get out.
"What we're experiencing is a bit of a lull in the growth rate," he says. "I prefer higher growth--if we are taking a vote I vote for more of that, please. But we're financially sound."
This isn't the first time Cisco has seen a market sour; Lang points to the Asian markets a few years ago. If patterns hold, he predicts anywhere from six to 18 months of a bear market based on historic trends.
"It's mostly an emotional shift more than anything else," Lang says. "It's a funny part of human nature that during the up times people try to convince themselves that it will never end and during the down times they scare themselves into thinking the downtime will never end."
To turn things around, Lang says service providers need to realize the downturn is not permanent and start forward with their rollout plans. There may be more of an emphasis on boosting customer take rates and revenue.
And it is important to note while Wall Street has been a wild ride, the customer uptake of broadband and Internet services has trended steadily upward.
"That's an important point because what that says is the base demand is strong," he says. "This isn't some fad--this isn't some pet rock thing. This is something that adds value and it will be as important a part of the landscape as the telephone network or the transportation infrastructure or any of these sorts of things, with a lot of great growth ahead of it."
All in all, the experts are consistent in saying while it may be a painful period, there is little reason to believe the Internet economy--and broadband in particular--will suffer permanent harm.
"Long term, the prospects in broadband have got to be good; there's just too much capital tied up in it and too many interesting applications (coming) down the line," Greenstein says. "In fact, some of this is okay in a Darwinian sense. It is sad, but it is what capital markets do well--the weak are eliminated and what remains is stronger on the whole."
Recovery will require companies to gain a more realistic market strategy, rather than the many unprofitable ones they are now offering, Rodriguez advises.
"Businesses are going to have to focus a lot more, and this will result in continued layoffs--it will result in spinoffs of businesses," he predicts. "I believe six months out we will begin to see additional merger and acquisition activity as these businesses begin to look for other people to run the businesses that heretofore have been part of a much more complex organization, so these organizations can begin to focus on what their core competencies are."
And Cisco's Lang thinks such lean, mean companies will get back in investors' good graces.
"The Internet is a very powerful, important thing with many years of good business to generate for all of us, both on the equipment side and the service provider side," he says. "But that being said, it is not a license to suspend the laws of business."
When all is said and done, Goldstein says the downturn won't go down in market disaster history alongside the Great Depression.
"We won't be having this conversation six months from now," he says. "The other side of the coin is it's only just a couple of months. For people whose idea of long term is tomorrow, this may seem like it's gone on for an eternity. But in fact it isn't that sharp and it isn't that long and it isn't that severe."
The bottom line for Goldstein is a variation of the old saw: everything new is old again.
"It's not as if because it is happening today, it will happen forever," he says. "For all that's new about the new economy in general, it ain't that new."
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