It's annual report season in Europe, and investors are bracing for the news of huge write-downs and losses from regional telecom companies. The reason is well known: These usually ho-hum, steady-as-you-go companies bet billions on acquisitions and licenses for third-generation mobile systems, then badly overestimated the speed at which Europe's next telecom revolution would unfold. Now, in the wake of the tech meltdown and the Enron Corp. scandal, investors want to know how that debt overhang will be cleared up. Here's a look at the problem and some solutions:
Q: How bad is the debt situation right now?
A: About as bad as it gets. Europe's carriers now owe creditors a staggering $285 billion. That's a huge jump in leverage in just three years. Starting in 1999, the telcos paid billions to buy other carriers and obtain third-generation (3G) wireless spectrum licenses from European governments. Although the auction bids spiraled wildly, most felt they had no choice but to participate or risk their futures. By mid-2001, telcos in 13 countries had spent $116 billion for 3G licenses, $80 billion in Germany and Britain alone.
Q: Why is this debt a concern right now?
A: Enron has drawn more attention to accounting issues and highlighted the financial risk from off-balance-sheet obligations. France Telecom's (FTE ) debt could soar by $5 billion this year if it is forced to pay off stock put options and buy out struggling German wireless company MobilCom. Meanwhile, continued weakness in equity markets has made share offerings--the cheapest way to work down debt--difficult. For example, Deutsche Telekom was planning an $8.8 billion initial public offering for its mobile-phone business this year and a $4.8 billion sale of its cable properties. Both are on hold, and the company now seems likely to miss its debt-reduction target for 2002. As a result, credit agencies may lower DT's debt ratings, raising annual interest expenses by as much as $88 million.
Q: Companies are writing down billions in assets. Will this reduce debt?
A: No. Writing down the value of acquisitions and 3G licenses only helps companies clean up their balance sheets. Responsible accounting dictates that assets be carried on the books at a reasonable value. But write-downs do nothing to reduce the loan payments. Indeed, such moves could make borrowing more expensive by slashing the available asset base against which companies can collateralize their loans.
Q: Is there any way out?
A: Near-term, the picture is bleak. British Telecom (BTPLF ) managed, through a combination of asset sales and spin-offs, to cut its debt in half before the market window slammed shut. Telecom Italia (TI ), too, plans to slash debt by $3.5 billion through asset sales. But France Telecom and Deutsche Telekom (DT ) already have exhausted the easy measures. They're still selling off a few assets here and there but mostly are waiting for equity markets to develop a renewed appetite for stock issues. Meanwhile, unhappy investors have pushed share prices down for both companies by more than 80% since their peaks. Their concern: If paying off debt soaks up too much cash, telcos won't have enough money to invest in new infrastructure or to market new revenue-generating services.
Q: How else might the telecoms lessen the debt load?
A: On Mar. 19, Deutsche Telekom announced it was cutting its dividend 40%, then announced the next day it was cutting capital spending 10%. Others are likely to follow. Another quick fix being contemplated is to securitize assets, such as the accounts receivable from fixed-line phone accounts. France Telecom hopes to raise $880 million this way in the first half of this year, Deutsche Telekom $1.8 billion. But the most beneficial long-term solution is to attack operating inefficiency. The Boston Consulting Group figures Europe's phone companies could boost the productivity of their invested capital by 30% to 40% through better network and customer management. Trimming head count, slashing the subsidies on mobile handsets sold to consumers, and dumping unprofitable customers also would boost cash flow.
Finally, one unlikely avenue is a full-scale government bailout, which would raise hackles in Brussels. Politicians in Berlin and Paris already have made some concessions, though: Germany will allow 3G providers to share the cost of building new networks, and France retroactively dropped the price of its 3G licenses by 85%.
Q: Can 3G services come to the rescue?
A: Perhaps someday. After all, the prospect of a river of wireless data revenues is what unleashed the 3G frenzy in the first place. But don't hold your breath: 3G services won't be rolled out for most of Europe until 2004. Indeed, building new networks and launching services could cost telcos $100 billion more, analysts say. Even then, the services may not unleash the hoped-for boon. That's one reason 3G licenses are being written down.
In the end, a painstaking combination of cost savings and new data services is the only way carriers will be able to end the debt crisis that dogs them all.
By Andy Reinhardt in Paris