Telecom Turmoil

Some big players are sagging, but this is no dot-com crash

Only a few months ago, the opportunities for telecom players seemed boundless. From long-distance giant WorldCom Inc. to upstart Level 3 Communications, companies were building sprawling communications networks across the country to carry the booming Internet traffic. Communications equipment makers Lucent Technologies Inc. and Cisco Systems Inc. were struggling to keep up with demand for their gear. And investors were all too happy to finance this construction of the Digital Future, buying $33 billion worth of telecom IPOs just since the beginning of 1998.

Now, formerly high-flying telecom players are struggling to regain cruising altitude. The Big Three long-distance companies have seen their stocks plummet more than 50% this year. AT&T shares got hammered 13% on Oct. 25 when CEO C. Michael Armstrong announced plans to break the company up amid deteriorating financial results. Even Verizon Wireless, the largest provider of mobile-phone services in the U.S., had to postpone its initial public offering because of stock market turmoil.

It may be tempting to conclude that the prospects for telecom players were as overhyped as those of flavor-of-the-month Internet startups. Certainly, profits across the telecom industry are dropping as too much capital investment chases too little revenue. Blake Bath, an analyst for Lehman Brothers Inc., estimates that the return on assets in telecom will drop to 8.5% this year from 12.5% last year.

Look carefully, though, and you'll see that there are bright spots in telecom. Younger, more nimble players that aren't bogged down with creaky technology have been able to capitalize on fast-growing services like Internet and wireless--and have been turning in stellar financial performances. Qwest Communications International Inc., the long-distance upstart that acquired Baby Bell US West Inc., reported sparkling third-quarter results on Oct. 24. "Let's not throw the baby out with the bath water," says Joseph P. Nacchio, Qwest's CEO. "From our point of view, we think this industry is strong."

The key is keeping up with lickety-split changes in technology. The latest communications gear is evolving at a rate that's dizzying even compared with the computer industry. The capacity of optical equipment, for example, is doubling every nine months--twice as fast as semiconductors. Such change creates opportunities for nimble startups and hazards for today's leaders. Consider how badly Lucent Technologies has stumbled. It missed the latest evolution of optical gear and blew Wall Street's financial expectations four quarters in a row. The missteps ultimately cost CEO Richard A. McGinn his job.

Even once-invincible Cisco is threatened. The networking giant's strategy, executed brilliantly for years, has been to buy upstarts just as their technology was going to be adopted broadly. But the latest twists and turns of the communications-gear market have left Cisco playing catch-up. It's losing share in the $2 billion high-end router market to upstart Juniper Networks Inc., and hasn't made much progress in the optical arena.

The lesson? The troubles of yesterday's stars shouldn't mask the prospects for tomorrow's up-and-comers. For every Cisco, there's a scrappy Juniper. For every AT&T, there's a speedy Qwest. Older telecom players may well recover from their current problems, but if they don't, new companies will take their place.

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