Telecom Bankruptcy Wave May Become Self-Perpetuating

As a handful of telecommunications companies begin to trickle out of bankruptcy protection, analysts fear their financial reorganizations could have unintended consequences that exacerbate the industrywide meltdown.

Many firms that went into Chapter 11 now are preparing to come out with leaner operations and smaller debts than competitors that didn’t file for bankruptcy protection--a cost advantage that threatens to perpetuate the industry’s instability. Already, bankruptcy alumni such as Covad Communications Group are undercutting the prices offered by their rivals.

To make matters worse, the spate of bankruptcy filings--punctuated by WorldCom Inc.’s record-setting case filed this week--so far is doing little to solve the industry’s underlying problem: a vast oversupply of fiber-optic networks.

“This may trigger many other bankruptcies, and that would be the worst case for a fast recovery of the telecom sector and a fast recovery in investor confidence,” said Roger Wery, head of the telecommunications practice at PRTM, a San Francisco consulting firm.

Analysts said WorldCom’s revitalization could do the most damage to rivals.

It’s not a foregone conclusion that WorldCom will emerge from bankruptcy protection with its debts erased and its strongest businesses intact. But that’s the scenario the company is hoping for--and the scenario its competitors fear most.

But WorldCom’s situation isn’t unique. It’s just the most visible example in a long line of telecom companies seeking a second chance in bankruptcy protection. Covad , which sells high-speed Internet access, paved the way.

The company filed for Chapter 11 protection in August with mounting losses and $1.4 billion in debts, but it left Bankruptcy Court four months later in trimmed-down shape and carrying debts totaling just $50 million. Covad’s pre-bankruptcy shareholders retained an 80% stake in the reorganized company and were not wiped out in the process.

Covad’s case was followed by scores of others, including McLeodUSA Inc., a local phone and data service provider, and Yipes Communications Inc., a data networking firm. Many others are on the verge of stepping out from under bankruptcy court protection, including broadband provider Mpower Holding Corp. and fiber network operators 360networks Inc., Global Crossing Ltd., XO Communications Inc., Metromedia Fiber Networks Inc. and Williams Communications Group Inc.

Williams, which filed for bankruptcy protection in April with $7.15 billion in debt, plans to emerge from Chapter 11 this fall with debt of $525 million. However, rival Level 3 Communications Inc. this week made an unsolicited bid to buy the company out of bankruptcy protection with an offer worth about $650 million.

So far, only a tiny fraction of telecommunications companies have survived bankruptcy protection. But those that have are going to make their presence known.

The most damage will be felt in the fiber-optic sector, which boasts as many as 20 companies selling bandwidth in some major cities.

Already, prices for high-capacity fiber links are well below cost and so low that they are a major contributor to the current flow of bankruptcies.

For example, a customer buying a fiber-optic link between Los Angeles and New York to carry 155 megabits per second of data would have paid $1.8 million a year for it in 2000. In 2001, that same connection cost $590,000 a year, and this year, the price has fallen to just $194,000, said Alan Mauldin, an analyst at fiber research firm TeleGeography Inc.

“Today, companies have to sell five times as much capacity to make the same amount of money,” he said.

The situation will be even worse as more and bigger players such as WorldCom drop their debt and lower their prices.

“They’ll go to all the major corporations and bid for their business with low prices,” said Susan Kalla, a telecommunications analyst with Friedman, Billings, Ramsey & Co. “The customers may not want to give the business to a company just out of bankruptcy, but they can certainly use them for leverage to get price concessions from other companies.”

Some firms are slashing their prices before they emerge from Chapter 11. XO Communications, a network operator which was loaded down with $4.7 billion in debt when it filed for bankruptcy protection last month, is waiving the monthly fee for many of its services and loosening rules to allow month-to-month commitments, according to David Willis, a researcher at the Meta Group. “That illustrates the type of behavior we’re going to see,” he said.

XO spokesman Todd Wolfenbarger acknowledged that the company has waived fees “to provide some sort of reward or incentive for being willing to come our way” during reorganization.

If the survival of the post-bankruptcy telecoms will only prolong the industry’s doom, why aren’t more of them liquidated instead? Mainly because liquidation isn’t a popular option for the banks, bondholders and creditors owed billions of dollars when the market is paying pennies on the dollar for valuable telecommunications assets.

“The reorganization of all these companies is more a function of the fact that the investors and the creditors are trying to get more of their money back,” said Glen Macdonald, a vice president at Adventis, a consulting firm. “If they liquidate, they have no chance of getting their money back.”

Not everyone buys the notion that the WorldCom bankruptcy filing and others will trigger a rash of additional bankruptcies.

“There’s a theory that goes that everyone files for bankruptcy because it’s going to be viewed as a healthy move and a way to wipe away the debt,” Willis of Meta Group said. But, “the probability of that happening is very low.”

The stigma of bankruptcy, the harm to valuable brands and the risk of losing customers will keep bankruptcy protection a last-resort option, he said. Instead, many companies will press their bondholders and banks for concessions, arguing that it’s in their interest to help the company survive against rivals with far less debt.

“There are restructuring and turnaround opportunities for some of these companies outside the confines of bankruptcy court, and some of these companies are going to have to do that,” Macdonald said.

Even if the industry begins to consolidate, the problem of overcapacity remains, analysts say.

“The problem here is that networks never go away--even if the company disappears, the assets don’t,” said David Passmore, research director at Burton Group, a network analysis firm in Sterling, Va.

“As each of these guys go bankrupt, the pain spreads to everybody else.”

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Times staff writers Jon Healey and Alex Pham contributed to this report.