Telecom CFO: Telephony and Cacophony

With flagging revenues and staggering debt loads, telcos must partner with rivals while patching together more sustainable business models -- a tal...
Marie LeoneJuly 3, 2002

How tough is it right now in the telecommunications sector?

Consider this: Eager to site a cell tower in an area with restricted construction, one wireless telecommunications company designed a tower in the shape of a cross and — in exchange for payment to the congregation — placed it on top of a church.

Even that plan backfired, however. Town leaders ultimately decided the cruciform antenna was an eyesore and forced the telecom service provider to take down the unholy cross.

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Clearly, desperate times call for desperate measures, and few CFOs face bigger challenges these days than telco CFOs. Most phone companies are bedeviled by overcapacity, cutthroat pricing pressure, and slower-than-predicted growth in wireless and Internet business units. That, in turn, has led to anemic cash flows — barely enough to service monstrous debt loads built up by years of network build-outs. So far this year, 12 telecom companies have been hit by credit downgrades, including stalwarts like AT&T and Sprint.

To stay in business, many telecom companies have been forced to share their underused bandwidth with competitors. The partnerships, often with fierce rivals, can be awkward at best. For a CFO, calculating fixed asset allocation and valuation records for a shared network involves revealing historical data. The rub: Few company executives are eager to fully disclose historical costs or cost models to competitors, for fear of tipping tip their hand during future negotiations. Says one industry watcher: “These partnerships put a premium on a CFO’s poker skills.”

Dial M for Mishigas

The partnerships also put a premium on a CFO’s budgeting and planning skills. One telecom consultant points out that joint budgeting can be a maddening task, even for the most experienced finance chief. Telecom budget horizons span anywhere from next Tuesday to five years out. While partnership agreements usually specify how to share revenue and expenses, the corporate finance departments of both companies must work together to figure out how to measure budget items — and how to fund projects.

Once a project is completed, the fun is just beginning. A national practice leader for one telecom consultancy points out that billing accuracy has been a bear of a problem for telco finance chiefs — even on in-house projects.

Often, older billing systems aren’t equipped to handle a marketing department’s “creativity” — things like multiple rate plans and contracts linked to promotional specials and customized orders. Further, sales staffs at phone companies are notorious for recording revenue differently than staff accountants. Telco CFOs must reconcile the numbers before the books are closed.

Indeed, several telecommunication companies have had trouble reconciling reported results, often because of accounting problems. In late June, for example, WorldCom announced it had uncovered accounting irregularities that would force the company to lower 2001 revenues by over $3 billion — the largest corporate restatement in U.S. history. The day of the announcement, WorldCom fired CFO Scott Sullivan.

A few months earlier, Metromedia Fiber Network Inc. issued earnings restatements for 2001. Why? Revenue recognition problems. Meanwhile, Wall Street is still waiting to see if Qwest Communications Inc. will have to rejig its past financial results pending an SEC investigation.

Telco CFOs are also struggling with accounting rules in a deregulated market. The old cost-plus method for asset accounting no longer flies in a competitive environment. And as accounting gets stricter, so will asset valuation associated with such things as overcapacity.

In fact, many industry analysts are screaming for telecom CFOs to write down assets or find another way to get rid of them.

If assets are not valued properly, the telecom death spiral begins. Low asset values weaken a company’s balance sheet. A weak balance sheet, compounded by poor cash flow, often lead to credit downgrades. Downgrades drive up the cost of capital and trigger loan covenants. Bankruptcy looms.

An exaggeration? Hardly. In the first quarter, the telecom industry led all sectors with eight credit downgrades — a dubious distinction. The list included AT&T, Qwest, and Nextel. In June, Sprint and Ntelos were hit by credit rating reductions, bringing the grand total of this year’s telco downgrades to 12, says John Puchalla, an economist at Moody’s. The downgrade reports of both Sprint and Ntelos cited, among other things, high leverage and spotty cash flow.

Things have gotten so rotten in Phone Land that independent financial research house Gimme Credit Publications Inc. named two telecom companies — WorldCom and Qwest Communications — to its “Bottom Ten” list of credit risks. The electric and gas sectors were the only other industries with two companies on the list.

IP or RIP?

Of course, these days, a lot of CFOs are used to shoring up credit and cash flow problems. But try doing it while you’re remaking your business model.

That’s exactly the scenario that faces finance chiefs at a number of smaller telecom companies. Take the case of David Frear, CFO at Herndon, Virginia-based Savvis Communications, which specializes in IP VPNs (Internet protocol virtual private networks).

In February 2001, Bridge Information Systems, which owned a majority of Savvis and accounted for 80 percent of the company’s revenue, filed for bankruptcy. Frear, a former banker and public accountant, recounts that to keep afloat, Savvis executives had to reduce the workforce by 12 percent (70 employees), eliminate overcapacity by growing the customer base, and make the network more efficient. A tough task, considering the sputtering health of the telecom market.

What’s more, the Bridge mess left Savvis in default of certain loan covenants, which squelched any additional capital-raising plans. The executive team sidestepped the problem by convincing investment bank Welsh Carson to convert its existing loans to Savvis into preferred equity, which gave the investment bank a 56 percent ownership stake in Savvis.

During this same period, Frear and other Savvis executives had to devise a new business model — one that didn’t rely on a single customer. Ultimately, Savvis management decided to repackage the company’s services, this time broadening the customer list of high margin, private users of financial data.

Remarkably, the plan seems to be working. Within four months of putting its reorganization plan in motion, Savvis turned an $8 million per month EBITDA loss into a $1 million per month EBITDA gain.

CFOs at more established telcos will be hard-pressed to mimic the Savvis plan, however. According to Zeus Kerravala, vice president of enterprise infrastructure at consultancy Yankee Group, “traditional telecom companies would have to totally refit their sales force” to move to a IP VPN model.

Until they do, CFOs at more established telcos will most likely be locked in a reckless price war. And they’re going to be stuck with a whole lot of unused assets. That’s not a good thing. Says one industry consultant: “There’s as much value in unused telecom infrastructure as there is in a 747 sitting on the runway with no doors.”