Dot-bombs rock economy, roil investors

As the finances of the telecommunications sector continue to deteriorate, rising debt defaults and bankruptcies are expected to send shock waves rippling through the economy.

In the last 18 months, 29 telecom companies have defaulted on $21 billion in debt, according to Moody’s Investors Service in New York.

Martin Fridson, chief high-yield strategist at Merrill Lynch & Co. Inc. in New York, expects to see another $20 billion in high-yield debt fall into default by yearend.

Those failures are hitting not only equity and fixed-income investors but also hundreds of suppliers, from Nortel Networks Corp., Cisco Systems Inc. and Broadwing Inc. to General Electric Capital Corp.

“It won’t cause a banking crisis,” says Tanya Azarchs, a managing director of financial service ratings at Standard & Poors. “However, it’s just one more straw on the camel’s back. It all piles on.”

Last week, Standard & Poor’s in New York downgraded Lucent Technologies Inc.’s debt to junk status.

And earlier this month, PSINet Inc., an Internet access provider in Ashburn, Va., filed for bankruptcy, listing $4.3 billion in debt.

More than half of that is in high-yield bonds in mutual funds managed by Janus Capital Corp., Fidelity Investments, Wellington Management and others.

Analysts don’t expect losses from the telecom industry to rival the savings-and-loan crisis of the late 1980s, which cost at least $150 billion. But losses are expected to be significant.

Since 1998, banks have lent $83.8 billion to non-investment-grade telecom companies, according to S&P in New York.

However, borrowings are spread broadly, so rating agencies don’t expect individual banks to suffer huge earnings hits.

Still, high-yield telecom debt has been trading at a 60% to 70% discount to the face value of the bonds.

“The market seems to think that the recovery might be anywhere from virtually nothing to maybe 25 cents to 30 cents on the dollar,” says Robert Konefal, a managing director who oversees telecom, media and technology ratings at Moody’s.

“In our minds, the haircuts are going to be quite steep,” he adds.

The seeds of the current telecom malaise were sown by federal deregulation of the industry in 1996. The move spawned dozens of new phone companies known as competitive local exchange carriers.

Internet service providers forecast a huge expansion in data traffic and the need to dramatically expand their networks, says John Page, a senior telecom analyst at Moody’s.

“The telecom industry went from nowhere to close to 20% of all high-yield debt in 1999, the largest sector in the high-yield market,” says Mr. Fridson.

The current slowdown has hit at the same time that many telecom upstarts need extra funding to build their networks and complete their business plans. However, the public markets are now essentially closed to those companies, he adds.

Moody’s has 16 telecom and cable companies on its watch for downgrades.

“It’s fundamentally an issue of liquidity,” says Mr. Page. “Companies are running out of money, and I expect more bankruptcies.”