The TeleChoice Take
We believe that, if approved, GX's proposed plan could cause horrible
repercussions throughout the industry for years to come.
A Brief History
Global Crossing was formed as a project. One customer needed capacity on
one route. Gary Winnick formed a corporation to finance and project manage
the creation of a new sub-sea cable and that initial project was successful
enough to encourage expansion of the business plan into network
construction projects around the world. Based on my early interactions
with Global Crossing, it was clear that the plan was to create a
company/asset base to flip -- to be acquired by a larger network operator.
However, in the crazy valuation days of the late 1990's, Global Crossing
quickly achieved a level of financial valuation that it could no longer be
swallowed by any other players. The absurdity of this situation became
apparent when Global Crossing, with a few hundred employees, made a serious
bid to simultaneously acquire US West and Frontier. Although Qwest outbid
GX for US West, Global Crossing did complete the acquisition of Frontier,
and with it gained a nationwide US fiber network, a number of disparate
business units, and most importantly a seasoned management and a full
operations team. Through this transaction, GX transitioned from primarily
being a network construction company selling dark fiber to a true network
operator fully equipped to sell capacity and finished services to both
retail and wholesale markets. A number of additional transactions
followed, but effectively this transaction defined Global Crossing through
to its current challenges.
How Did Gary Winnick transform a $20M investment into a company with $25B
Global Crossing's balance sheet lists approximately $25B in assets, of
which over $12B are property, plant & equipment -- basically their network.
This has been created using a variety of financing vehicles. Of greatest
interest are three types of transactions:
- GX offered stock on the public markets. Shareholders invested their
personal and institutional funds to become part owners in the company,
expecting that overall growth in the telecom market and GX's specific
successes would result in near-term or long-term return on their
- GX acquired companies (most notably Frontier) by using newly-printed
stock as its currency. Effectively, shareholders of these acquired
companies invested their cash to create assets and then agreed to exchange
their ownership in their original companies for an ownership stake in GX.
- GX was loaned money by bankers and other institutions, typically in
the form of private bonds, with the agreement that Global Crossing would
pay the money back with interest in the future.
What's the plan?
Not being either a lawyer or an accountant, I'm sure this is overly
simplified, but in simple terms Global Crossing has recruited two firms to
invest $750M as part of an overall restructuring of the business to enable
Global Crossing to exit from bankruptcy as an operational company. As a
result of the proposed plan, all existing shareholders would be left
without any ownership in the company nor compensation for the funding they
provided directly and indirectly towards creating a $12B network. Under
the proposed plan, debt holders would receive pennies back for each dollar
they provided to GX in building a $25B company. Those pennies would be as
a combination of cash, new stock in the restructured company, and some
redefined debt holdings. The two "rescuing" companies, for their $750M
investment, would receive majority ownership in the company, its $12B
network, and the remaining assets in the $25B company, including customers
and existing revenue streams.
Effectively, under the proposed plan, Global Crossing would emerge with
virtually all of the costs of building one of the world's largest networks
completely wiped away. Their costs would merely be limited to the
incremental costs of operating that network. They would be allowed to
price and sell their services based on a tremendously advantaged cost
structure relative to the rest of the industry.
I've never really paid much attention to the airline industry, except of
course when they leave me stranded in St. Louis or send my luggage to the
wrong corner of the world. However, I have some vague recollections of an
industry under tremendous pressure for a very long stretch of time. The
pictures that I have in my mind include:
- Deregulation leading to emergence of a large number of competitive
- Bankruptcies by new entrants and a number of long established
- Some of those carriers being allowed to emerge from bankruptcy with
tremendously restructured balance sheets.
- Those carriers using their advantaged cost positions to launch price
wars to fight for survival.
- Most of those once-bankrupt carriers eventually disappearing anyway
since their problems really stemmed from significant challenges in their
operations and unsustainable positions in the industry.
- However, through their irrational and unfair pricing practices,
driving the entire airline industry into a long period of poor performance
with the vast majority of airlines (some years, all except Southwest)
operating at a loss year after year.
I fear the same scenario for the telecom industry if Global Crossing and
others are allowed to emerge from bankruptcy with tremendously unfair cost
positions. The end result could easily either be a very long period of
tremendous pressure on all players in the industry (including well
established players such as AT&T, WorldCom and the RBOCs, as well as all
new competitive entrants), and/or an expensive government bailout to
stabilize the industry. The burden of this activity will painfully fall on
telecom investors, taxpayers, or both. The result will be an even stronger
investor retreat from the sector and a much longer period for the industry
to emerge from the Slow Motion stage of the Innovation Cycle required to
lead to industry recovery and growth. The net impact would not be positive
for telecom carriers, their employees, their suppliers, their investors, or
their customers. With the possible exception of a few interested parties
involved in this transaction, this does not look at all like a winning
scenario for anyone.
This is fundamentally an issue about financial viability of players in the
telecom industry. The destiny of Global Crossing, at this point, lies with
its creditors. In reality, I believe those creditors likely have the
ability to drive the outcome of Global Crossing to whatever end they
desire. In practice, they face a situation where their existing debt
becomes virtually worthless (shut the company down, try to sell the assets
in a market where no one is buying), or where they can potentially extract
something for their investment (albeit, pennies on the dollar).
However, these debtholders, in large part if not in whole, are not
exclusively tied to Global Crossing. Most or all of them also have money
sunk into other telecom companies who face similar uncertain futures and
who will undoubtedly be impacted (probably negatively) if GX is allowed to
restructure as proposed.
The fundamental reality for the telecom industry is that there has been
over investment in the creation of too many players, all of whom set
investor expectations that they would be a major national/global player.
Either there will be a quick shakeout to a manageable set of survivable and
financially viable players, or there will be a long drawn-out process of
continued pain and economic challenge for all (too many) players.
This major event provides the impetus for a significant industry
restructuring. It is unclear whether the debtholders hold enough of the
pieces to achieve this restructuring unilaterally; it is unlikely. There
likely will need to be regulatory forces brought to bear as well, but
luckily those debates and discussions are also at the forefront of public
and political attention.
We see two potentially viable industry structures. We favor one, but
either would be better than the pain implied by the proposed GX
Under our preferred outcome, the industry is restructured into a small
number of competitors focused on optimally building and operating the core
infrastructure for the industry. There are many potential ways of
achieving this and many potential structures. Although technology and
innovation have their role to play, the reality is that telecom is a scale
business and financial viability is driven by achieving scale and
utilization. We believe that this must happen both in the long haul and in
the local markets.
The long haul consolidation can likely occur under the direction of bond
holders as they deal with how to protect their investments in challenged
operators including Global Crossing, 360 Networks (whatever is left), Level
3 (has indicated they may face creditors in 2Q), and Williams (has
indicated that they are trying to work with creditors on perceived issues).
The combined scale and utilization of these businesses would likely be a
strong base for one major competitive player with Worldcom, AT&T, and
Sprint representing other strong competitive players in their core network
The establishment of a local infrastructure industry is much more
challenging, even though companies such as McLeod and XO (and many already
failed CLECs) represent some opportunity. The dominance of the ILECs in
both assets (scale) and traffic (utilization) likely means that such a
combination of local assets would not represent a viable competitor. A
more likely driver would be regulatory, with the splitting out of wholesale
and retail businesses. The wholesale business could operate as a regulated
entity encouraged to provide universal service and to enable multiple
competitive retail offerings. This approach would align well with other
efforts to encourage aggressive broadband roll-out on top of which a number
of both traditional and innovative services could be delivered by both core
(e.g., ILEC, AT&T, Worldcom/MCI, Sprint) and focused competitive (e.g.,
CLECs and new niche specialists) providers.
We believe that this scenario creates the most attractive outcome for both
telecom investors (accelerating the entry of new capital to drive growth
and innovation) and telecom customers (especially enterprise customers who
value innovative services) and therefore would lead to the best growth
prospects for the industry.
The second potential outcome is a full return to the traditional,
vertically integrated business model under which the industry has
historically operated. In this scenario, the long haul and global assets
of players such as Global Crossing likely are subsumed into the RBOC
businesses. Existing services and customers of these competitive players
probably help the RBOCs in their quest to extend from consumer dominance
into valued provider to business customers. It is not clear how this model
could play out to strengthen the competitive position of the traditional
long distance players (AT&T, Worldcom, Sprint), so this scenario likely
also implies a return to having a single dominant provider in each RBOC
region, with competitive players having some success in specific niches.
We believe that this scenario, although healthier than what we envision
happening under the proposed GX outcome, would provided limited
opportunities for telecom investors and would inhibit service and
Disclaimer: I do not directly own any (now worthless) stock in Global
Crossing, although I likely do indirectly through some of the mutual funds
in which I participate. I do own stock, both directly and indirectly in
Global Crossing competitors, suppliers, and customers. I have not
considered the impact of the final outcome of Global Crossing's situation
on my personal finances in the sharing of these opinions.