Telcos - credit crunch

Fears for the future as phone companies run out of credit

Even big phone companies are struggling to raise money, and that means investment in innovation is likely to fall

Nortel Networks, the Canadian telecom equipment company that was once among the darlings of the digital technology world, slipped closer to outright bankruptcy last week, its market capitalisation down from a peak of $250 billion to a puny $250 million. Alcatel-Lucent is also in trouble, and even next-generation equipment companies like Ciena are predicting slow sales.

Some of this simply has to do with a long-standing shift in the telecom business as internet-based technology supplants traditional circuit-switched telephone systems. Nortel made its big mark back in the 1980s when it led the move to digital telephone network switches. But with the growth of landlines stagnant at best and more and more telecom traffic of all kinds flowing over the internet, there simply isn’t any demand for old-style $50 million telco switching systems.

But there is something else going on too, something much more ominous for the telecom and internet industries: the credit crunch is shutting down the borrowing that network operators depend upon to invest in their networks.

During the dot-com bust of 2000-01, telecom was among the last pillars to fall, but it fell hard indeed. In the late 1990s, a rush of investment led to excess capacity in many long-haul fibre networks in particular, and bubble-driven fraud at companies like WorldCom and Qwest didn’t help either.

The end result, though, was a lot of infrastructure, even if the companies that built it never reaped the benefits. Indeed, heavy investment in broadband networks during the dot-com years did much to pave the way for the Web 2.0 internet renaissance; online video, and all manner of always-on services that we’ve come to take for granted, simply didn’t exist in the 1990s because lots of people still relied on dial-up.

Now, though, there is a very real risk that reduced investment in telecom networks will depress demand for new products and services. Here in Missoula, Montana, for example, the AT&T-affiliated network that supports the Apple iPhone has very poor service. Apple won’t be selling many iPhones in Missoula until that issue is fixed, and that will take money.

While DSL and cable modem services are fairly ubiquitous these days, the definition of what constitutes true “broadband” is shifting, and it will take continued investment to keep pace. In both fibre-based broadband services, where phone companies are pushing into on-demand video to compete with cable, and in wireless services, where true broadband is only just emerging, a lot more money still needs to be spent.

Phone companies like Verizon, AT&T and BT traditionally have had no trouble selling bonds to raise money for capital investment; their prodigious cash-flow from subscription services made it some of the safest corporate debt around. But in an era when no loan is considered safe, even the telcos and their rivals face, at a minimum, sky-high interest rates if they want to borrow.

At the very least, a telecom investment drought is likely to reduce the possibility of robust competition in broadband services, which today exists in some places but not in others. Even in the best of times, strategies such as Verizon’s fibre-to-the-home service for video are risky, and if money is too expensive or unavailable those investments will not happen. The same is true on the wireless side.

It remains to be seen how substantially the recession will impact consumer spending on telecom devices and services in the short term; certainly there will be some effects, though at least a basic mobile phone is a necessity these days, and subscriber growth continues in the developing world. Entertainment-oriented services for their part have traditionally been fairly recession-resistant.

If telecom companies reduce infrastructure investment because they anticipate reduced demand, that’s a normal business cycle taking its course. But if some of the world’s largest and most stable companies can’t invest because they can’t borrow, that’s a different kind of problem, and one we can only hope will be fixed in a hurry.