Consulting » Telecom balance sheets attract business

Telecom balance sheets attract business

As debt-laden telcos wrestle to win business in a declining market, FDs can afford to select communications providers on the basis of their balance sheets rather than the promise of cut-price telephony.

France Telecom announced in September 2002 that it was entering a period of vast restructuring to cut losses that had spiralled to £7.7bn in the first half of the year, and to escape a growing mountain of debt which currently stands at £44bn.

Michel Bon, its former chairman, who resigned in September, said after his departure: “France Telecom cannot continue to survive when no one wants to lend us money and, on the contrary, when everyone wants to be paid on the nail. In current markets, the refinancing of our debt is simply out of the question.”

Telco giants like France Telecom are crumbling as the J-shaped telecoms growth curve predicted by analysts in 2000 has twisted horribly into a series of L-shaped drops in both revenues and share prices. Customers have not materialised in large enough numbers, and over-expansion through costly acquisitions has left many telcos with massive debts that they simply cannot repay.

But, while governments bail out incumbents like France Telecom, the stand-alone providers of voice and data services, equipment manufacturers and network specialists have a more desperate fight for survival.

For large corporate consumers of telephony this poses as many problems as advantages. On one hand telecoms infrastructure and services are getting cheaper. On the other, if service providers or equipment vendors go to the wall, so does business continuity. At worst, services can be terminated without warning.

Eddie Murphy, senior consultant at telecoms analyst Analysys, has started to see a major change in the way that corporates buy telecoms in the wake of the recent financial disasters at companies like Marconi, WorldCom, Global Crossing and KPNQwest.

“For the first time we have seen situations where network providers have gone bankrupt and networks have just been switched off. This makes corporates very nervous because they don’t spend millions of pounds on telecoms just for the fun of it. They spend it because communications is absolutely core to the business they do. If telecoms get switched off then client businesses shut down,” he says.

Murphy believes that client corporates are now making their telecoms choices based on the financial stability of the provider, and FDs must ask themselves if they can justify spending millions with a telco if it’s going through massive debt restructuring or divesting much of its communications business to keep afloat. “The issue of vendors financial stability is absolutely core for client corporates. Business continuity has shot right to the top of the agenda, far higher than price,” he says.

Julian Hewett, chief analyst at Ovum agrees. “There has been more interest in the financial credibility of companies. You need to look for a company with a strong balance sheet and positive cash flow going forward. With those two ingredients you will be safe,” he says.

Hewett also feels that, as many telcos change their product offerings to find a niche in the market, this poses an added risk to corporate consumers of telecoms. “You also have to decide whether these telcos will be offering the same service in a year’s time. Not only are businesses getting more conservative about the type of company they deal with but also the type of service that they choose. They don’t want to be one of a few customers on a service that is disbanded,” he says.

In essence, FDs have four options when buying telecoms: they can go for the cheapest deal; outsource to large telco with a strong balance sheet; turn to the incumbent; or purchase equipment direct from manufacturers and build their own system.

John Allkins, CFO of $2.5bn turnover data and communications provider Equant warns against the first option. A lower price means an uncertain future, he argues. “Price pressure is continuing, even though the market had thought the demise of WorldCom, who aggressively and triumphantly led pricing declines, would ease price cuts. But there are companies like AT&T and BT Ignite that are continuing to reduce prices. This isn’t something that Equant would try to match,” he says. “I spent much of last year telling analysts that WorldCom’s pricing strategy was unsustainable. Looking at WorldCom’s 10K filing before the scandal broke I thought that the company was trying to increase revenues to keep its credit lines. What nobody realised is that WorldCom was maintaining revenue growth at very low prices but also showing a fictitious profit.”

Like many telcos Equant is losing money. But Allkins also has a particular problem. Equant is owned by France Telecom, and, if the incumbent decides to pull the plug and offload the business – as it recently did with its German operation MobilCom – the company must go it alone in a declining market.

“Equant is positioning itself as a survivor. We will either be the winner in data-centric communications, or one of the winners. It depends on how bullish I am feeling,” says Allkins. “We are exceptionally well funded and have a very focused workforce. What’s changed is that we have found need to talk more about the sustainability and long-term position of the company. I even sometimes get questions about my accounting techniques.”

Allkins’ policy is to lay his books open to potential customers and let them judge if Equant will be able to see through its contractual obligations: “We’ve recently managed to stem a huge cash outflow. Our outflow, if measured by looking at bank accounts, is about $1m to $2m a week. As I’ve got over $400m on my balance sheet and a side loan agreement I can draw down for $300m that gives me the ability to show potential customers Equant is here for the long term.”

Before joining Equant, Allkins’ 10 years in senior financial management at BT puts him in a strong position to appreciate the threat that the incumbent now poses to his business. BT’s 20 million-strong customer client base, a lot of inertia and restructured balance sheet means that it can mop up a lot of corporate business. But Allkin’s hopes that a tendency for incumbents to pull out of non-core business areas when the going gets tough will temper the flow of business to BT. He argues: “In this global market we may find that large companies pull away from using the incumbent because there’s a risk that it will retreat at any moment to its home turf”.

Murphy claims there’s another reason why BT won’t be considered in isolation as large corporates still want to dual-source. “You cannot get this only from the incumbent,” he says. The only alternative may be DIY telecoms, where businesses build their own systems by purchasing equipment direct from the manufacturer. Recently both Diageo and Deutsche Bank have struck such deals with equipment vendor Cisco, tailoring their purchases to exactly fit their telecoms needs.

Ian Roche, UK financial controller at Cisco, helps his sales force package bespoke deals for UK companies. “Some companies may feel that as large telcos and service providers are under pressure they cannot predict winners and may wish to build their infrastructure in-house. Companies need to work out whether or not they are comfortable outsourcing telecoms completely to a service provider.

“When clients are looking to make a capital investment they are looking for a quick return. Companies are undertaking much more analysis internally before making a purchase decision,” Roche says. “And, if financial viability is an issue, and for a number of the large service providers it will be, then Cisco has a competitive advantage.”

Manufacturers like Cisco are in a strong position. Not only do they sell direct to businesses, but they provide the infrastructure for many of the telcos, too. And, with Cisco’s strong financials – they are still making money – Roche says that most of his customers are not concerned about continuity of service.

Both the analysts and telcos put many of the telecom sector’s problems down to the image of the industry. The practice of aggressive earnings management that crippled the likes of WorldCom, delays to the roll out of emerging technologies such as 3G, and too many expensive acquisitions have forced the sector into steep decline.

Another critical problem for telcos is that, even though businesses are still buying their services, very few clients are willing to stand forward and sing their praises. You can hardly blame them. If the finances of a mission-critical supplier are hanging in the balance, shareholders would not appreciate their companies shouting about it.

Nevertheless, too many businesses rely on telecoms for the sector to sink into oblivion. Whether or not the incumbents gain more market share or we see the industry stabilise through consolidation is in the hands of the customers and the way that they select suppliers. FDs need to look at the supplier’s history, funding capability and technical competence as well as headline price. They also need to understand that if they sign a three, five or even 10-year contract that they are building a partnership with a supplier that lasts until the end of the contract.



The title of a Merrill Lynch (ML) report on Alcatel from August 2002, “No Relief in Sight”, just about says it all. ML believes that Alcatel’s targets of achieving flat sequential H1 and H2 2002 revenues is over-optimistic given current capex scrutiny by telecoms carriers, the core of Alcatel’s client base. ML estimates that Alcatel’s revenue per employee in 2003 will be ?210,000, compared to ?295,000 for Nortel Networks.

Cisco Systems

Cisco, the worldwide leader in networking telecoms equipment for business, is a rarity in the telecoms sector – it still commands a “buy” recommendation from the equity analysts. Continuing to play on its strength in the enterprise market, Cisco maintained its lead over its rival telecom equipment manufacturers for the second straight quarter in Q2 2002. It now has 14.6 per cent of the communications equipment market.

Major client wins for Cisco in 2002 include large-scale contracts to supply communications infrastructure to Diageo and Deutsche Bank.


Ericsson divested of its direct enterprise equipment business in 2001, which now operates under the name Damovo. It currently concentrates on supplying telecoms infrastructure directly to carriers. But Ericsson expects to make a big impact in the enterprise space through future roll-out of 3G mobile services.

Standard & Poor’s down-graded the long-term credit rating of Ericsson from BBB- to BB+ in August 2002.

Lucent Technologies

Reports of an expected 25 per cent fall in Q3 2002 revenues just add to Lucent’s woes. The company has been badly hit by the drop off in the customer base of the major carriers. While there are no details of recent client wins from other sectors of UK business, Lucent’s UK press office claim that it “does have customers but they are not willing to be named at the moment.” Recent telco clients include BT, Orange and COLT.


Late in 2001 Motorola COO Bob Growney announced that he wanted the company to be as successful financially as it is technically. The company, which specialises in mobile services and wireless network infrastructure, has made strides to fulfiling that promise. Since January 2002, Motorola implemented planned cost savings and its share price has only lost 20 per cent of its value since the beginning of 2002 compared to an average 45 per cent reduction for the overall telecoms sector.


Nokia, the world leader in mobile telephone handsets, which also produces telecoms networking equipment, cut its sales target for the third quarter in a row in September 2002. Nokia blamed the downturn in the network equipment market, which represents about 30 per cent of its total revenues. In a statement, Nokia said the market for GSM mobile networks “remained challenging, with operator investments showing greater-than-expected declines”.

Along with Cisco, Nokia is the only telecoms vendor in the big eight expected to post positive net income this year.

Nortel Networks

In August 2002 Nortel announced a programme of redundancies aimed to bring its break-even point more in line with its current sales level.

Analysts SSB currently expect Nortel to post revenues of $10.8bn in 2002, down from its previous prediction $11.4bn. But analysts are concerned that the cuts might impair competitiveness, opening the door for companies like Cisco to take more market share.

Latest UK deals include providing voice and data solutions for LloydsTSB, M&G Investments and William Hill.


September 2002 research from analysts SSB argues there are still numerous risks to Siemens’ future outlook. “Despite the longer-term restructuring potential we see a difficult period for guiding expectations and delivering against them. With hopes of a communications equipment recovery being pushed back into 2003 or 2004, the year-on-year bottom-line progress that we hope for next year (to September 2003) is at risk,” it says.

UK-based clients of Siemens Information and Communications Networks division include Ford and BMW.

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