Technology's Unholy Convergence

The meltdown in telecom is flattening other digital sectors

It was supposed to be a perfect marriage--joining computers to high-speed digital networks to give a user in, say, Hoboken, N.J., access to the complete works of Mozart in Vienna. The world's telecommunications carriers would build these networks. And the broader tech industry--including makers of software, servers and routers--would supply the parts and service. Sun Microsystems Inc. (SUNW ) CEO Scott G. McNealy likened it to "the biggest equipment business in the history of anything."

But the dishes started flying last fall. As telecom's prospects have gone from sluggish to grim, its meltdown is helping to push an already sinking tech industry even deeper into the hole. That wouldn't have been true a few years ago, when telecom and computers were isolated markets that produced their own gear and ran on separate business cycles. But in this era of digital convergence, telecom and tech have become entwined like the twisted copper wiring of bygone days. Now, it's software, microprocessors, and computers that power telecom's high-speed networks--and they are suffering mightily from its slowdown. "As people grow to appreciate how much of the tech sector was telecom-related, they should realize that a recovery in technology will remain highly dependent on a recovery in telecom," says Leo J. Hindery, ex-CEO of AT&T Broadband and Global Crossing Ltd. (GX ) "Until that happens, we will have extreme overcapacity in parts of the economy."

That doesn't mean telecom alone accounts for tech's woes, of course. Until recently, the seemingly unstoppable tech sector accounted for about 30% of the country's economic growth. The slowing of the economy, along with capital spending overall, took much of the steam out of the industry even before the depth of the telecom slide became apparent.

Still, telecom's collapse is now speeding tech's descent--and that's likely to continue for a while. Telecom's prognosis has grown increasingly worse in recent weeks, dashing hopes of a turnaround in the second half of 2001. Now, 2003 or later looks more realistic. Telecom-gear manufacturing jobs fell about 6%, from 282,000 to 265,000 from December to April, says David Wyss, chief economist at Standard & Poor's Corp. Nortel Networks Corp. (NT ) alone has announced 10,000 additional job cuts since then. The Canadian company stunned observers on June 15 by warning of a second-quarter loss of $19 billion. Days earlier, S&P lowered the bond rating on gearmaker Lucent Technologies Inc. (LU ) to junk status.

BATTERED BANKS. Moreover, fears are rising that more carriers and gearmakers will join upstarts Teligent Inc. (TGNT ) and Winstar Communications Inc. (WCII ) in bankruptcy court. Big lenders such as Wells Fargo & Co. (WFC ), which has already announced a $1.05 billion telecom-related charge against earnings, face mounting losses. Lenders could ultimately lose a third of the $500 billion they have poured into the industry since 1999.

What's bedeviling telecom is extreme overcapacity. That's especially true in long-distance networks. Investors have poured $1.2 trillion into the construction of U.S. networks over the past three to four years, but only 13% to 15% of those assets are in use, Hindery says. Companies laid new lines even as advances in optical technology swelled the volume of digital traffic each line could carry, says Hal R. Varian, dean of the School of Information Management & Systems at the University of California at Berkeley.

Rising investment in telecom drew plenty of tech companies into the frenzy. Sun, for one, quietly built a multibillion-dollar business selling specialized servers designed to fit inside big telecom switches from Nortel, Lucent, and others. All told, Sanford C. Bernstein & Co. analyst Toni Sacconaghi says Sun got 36% of its revenue in fiscal 2000 revenue--and 60% of its revenue growth--from sales to the telecom sector. Much of that is now gone. To a lesser extent, Hewlett-Packard Co. (HWP ) and Compaq Computer Inc. (CPQ ) also benefited from selling servers and other computer gear to run high-speed networks.

Or take the semiconductor industry, which is getting an increasing share of sales from telecom. Today, chips for everything from cell phones to big phone switches account for about 23% of the industry--and with those markets tanking, it's no surprise that 2001 is likely to be the worst year in chip history. Then there are the contract manufacturers. Powerhouse Solectron Corp. (SLR ) gets 65% of its revenue from telecom and data networking. Those sectors account for 72% of revenue at rival Sanmina Corp. (SANM )

CANCELED. Software makers aren't immune, either. Scaling back ambitions for its digital cable network, AT&T (T ) has canceled plans for an advanced set-top box powered by Microsoft Corp. (MSFT ) Telecom sales at Oracle Corp. (ORCL ) topped $1 billion at their peak, say analysts. That's down at least 25% in the past year.

High-speed networks had also been driving sales of PCs to homes and offices. In a speech last year, Dell Computer Corp. (DELL ) founder and CEO Michael Dell noted that half of all new digital-subscriber-line and cable-modem subscribers buy a new PC within a year. Many of them, he said, buy multiple PCs for the home. But as of 2000, only 11% of online households had a broadband connection--one reason for the falloff in PC sales and tech spending, complains Dell. Says UC Berkeley's Varian: "Lots of people are pinning their hopes on broadband." That has proven a poor bet for tech. Cable operators and telecom carriers may not have single-handedly dragged down software and hardware makers, but they're sure not helping them get back on their feet.

By Steve Rosenbush in New York, with Peter Burrows, Jim Kerstetter, and Cliff Edwards in San Mateo, Calif., Andrew Park in Dallas, and Michael Mandel, David Rocks, and Heather Timmons in New York

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