Goldman Sachs Takes Axe To Telecom Market

Analysts at Goldman Sachs & Co. took the axe to many of the high-tech
industries biggest names Wednesday, downgrading stock value ratings in the
face of continued market conditions and financial difficulties.

The investment firm’s analysts were indiscriminate in their concerns over
which types of companies were to blame for the bullish tech sector and
predicted the problems to last at least through the second half of
2001. Downgraded were competitive local exchange carriers (CLECs), Web
hosting companies and long-haul fiber carriers.

In a report released to investors Wednesday morning, the firm hit the
telecommunications market hardest, giving a thumbs down to five CLECs in
the U.S.: XO Communications, McLeodUSA, Network Plus, Focal Communications
and Net2000.

The five independent voice and data companies, already facing flagging
stock values from shaky investors, will continue to see problems until
conditions in the marketplace and their own operations change, the report
said. However, it continued, the sector’s long-term value shouldn’t be

“To varying degrees stock prices already reflect this pessimistic
assessment, but we believe that the group will continue to underperform
until various challenges are worked through,” the report
summarized. “Despite our continued near-term caution on the group, we
believed that the long-term thesis is intact namely, that the
best-managed, well-capitalized CLECs will capture significant market share
by virtue of their service intensity, bundled offerings and attractively
priced service packages.”

Inter-related factors led to the firm’s low opinion of independent
carriers, a three-headed chimera that is causing many independent companies
to collapse:

  • High debt levels, which eat into any company profits almost before it
    can be spent.
  • Nearly non-existent equity funding, which was responsible for the huge
    growth by CLECs the past three years and subsequently responsible for the
    huge debt load now. Operations that used to be funded primarily through
    venture funding are now reliant on actual company revenues, which can
    hardly support the many different costs.
  • Lowered earnings before interest, taxes, depreciation and amorization
    (EBITDA) ramp assumptions caused by the high debt load.

In the hosting sector, Goldman Sachs used Loudcloud, Inc., as its example
of what young, upstart infrastructure company face in today’s bullish
market. The company, with only $11.7 million in revenues last quarter,
managed to rack up $60.3 million in losses mainly due to increased demand
and equipment rental costs.

Despite the Loudcloud’s increased customer base, the investment firm
considers the opportunities for Web hosting companies “finite” while the
risk for investors is “prohibitively high.” Also appearing on Goldman
Sachs downgrade list were Exodus Communications and Equinix, Inc.

In the fiber carrier market, WorldCom, Inc., Level 3, Williams
Communication Group and MetroMedia Fiber Network, Inc., were downgraded.

It was no news that MetroMedia faced downgrade by Goldman Sachs and other
investment firms in New York. The company, already on the financial ropes,
announced last week it received a one-month extension to make its $350
million payment to creditor Citicorp.

But investors are wary about the continued value of a company that can’t
make its payments. With a certain amount of irony, Goldman Sachs analysts
said that investing in MetroMedia is “only suitable for investors with the
highest tolerance for risk;” not a ringing endorsement by any stretch of
the imagination.

Analysts weren’t worried about the company facing liquidation in the near
future, however. Metromedia’s operations, which consist of
facilities-based connectivity for corporate customers and telephone
companies alike, is in little danger of being completely wiped out.

Meanwhile, Level 3 and Williams have been hampered by the slowdown caused
by the “last mile” carriers, notably the data competitive local exchange
carriers (DLECs) and CLECs. Because these carriers rely heavily on the
telephone companies that are having a tough time deploying their digital
subscriber line (DSL) and other broadband services, Level 3 and Williams
have been taking huge losses.

That, despite figures by Goldman Sachs which show that while demand for
fiber optics in the U.S. has been growing at a rate of 100-200 percent
every year, the demand hasn’t been nearly as much as analysts had planned.

“As a result, pricing has fallen more rapidly than expected, averaging over
50% on some common inter-city routes this year, such as NY-LA,” analysts

Also affected was the WorldCom Group which has seen its net income drop 27
percent, before accounting, in the last quarter. A combination of the
slowdown in Internet growth and the company’s continued existence in the
long-distance market, causing them to be downgraded from recommended to
market outperform.

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