Telcos Reign in Spending, With Ripple Effect

When big-spending companies say they’re tightening their belts, your portfolio might end up feeling the pinch.

A bunch of hefty telecommunications firms have said they plan to reign in their capital expenditures next year. Slower-than-expected sales and trampled stock prices have hurt these once freewheeling companies, and now the spending slowdown is adding to investors’ jitters about future growth prospects of not only these companies, but also of the networkers and equipment companies such as Cisco who are the beneficiaries of the recent spending spree.

And even if you’ve shied away from these more volatile stocks, you may indirectly feel the effects of this penny-pinching: These warnings could be yet another sign that the economy is slowing down, which has across-the-board implications.

Backing Off Big Budget Projects

Why the sudden restraint in shelling out money for building next-generation communications technology? For one thing, loaners aren’t so interested any more in funding these costly projects, forcing many telcos to curb their spending budgets.

BellSouth, which controls local phone service for nine Southeastern states, is among the companies pulling back. The company has said it plans to reduce its 2001 buying budget to between $5.5 billion and $6 billion, down from this year’s planned budget of between $6 billion and $6.5 billion. BellSouth also cut its earnings projections for 2001, citing the costs of developing high-speed Internet access and business ventures in Latin America.

Other large telecom companies have followed suit, namely AT&T, WorldCom and Williams. They have said they will spend less on such equipment as telephone switching gear and routers next year.

“The telcos have over-stretched themselves and will be weak performers next year,” says Michael Boldin, director of real-time economics at in West Chester, Pa. “In the phone business prices are falling, and so are margins, and this is a clear sign that supply has outstripped demand. It’s no surprise that these companies are cutting back.”

Ripple Effect of Reductions

But it doesn’t end there. Reduced spending on technology for one company means less business for another, says Robert W. McLeod, professor of finance at the University of Alabama in Tuscaloosa. If a large buyer of technology, such as a regional telecom firm, says it will spend less on equipment and infrastructure it has a negative impact on it suppliers — in this case technology companies such as Cisco Systems and Lucent Technologies.

“There is some concern out there as to where the new demand for technology is coming from, and some people are questioning these companies’ ability to grow beyond their saturation point,” says McLeod.

Capital expenditure — the outlay of money to acquire or improve anything from company furnishings to technology — is vital to a growing a business, says McLeod. “A company that’s not spending enough could end up with out-of-date and inefficient technology,” he says, adding that in fast-paced industries such as the high-tech sector this can be fatal.

But a cutback in spending isn’t always bad news, he adds. In many cases a company is simply in tune with its current economic climate and is showing it can plan for the future well by not investing in parts of its businesses that are going to remain idle.

The difficulty is deciding which companies are exercising good economics. A good way to do this is to examine what a company has told its investors in the past. If a company said it would do a major capital expenditure then cuts back because of a lack of demand, or because the markets change, it’s bad news, says McLeod.

But if a company has a strategic plan to do something in five years or so, and you see that it has completed the project and is seeing a slowdown, there’s no need to make any more expenditures of capital, he adds. “It is hard to see a clear distinction without researching a company’s strategic plan and its earnings reports.”

Indeed, companies like Level 3 Communications and Global Crossing are no longer in the primary stage of building their networks and so are less reliant on capital, he says. These companies spent large amounts of money on infrastructure projects started last year when the markets were doing well, and they are now almost complete.

Pressure From Investors

However, in business what companies do and what they say are often two different matters, says Michael Hodel, a telecommunications analyst at Morningstar. Despite a planned budget of between $6 billion and $6.5 billion this year, BellSouth has already spent $6.8 billion over the past 12 months, he says.

“Investors in these companies don’t like to hear that big capital expenditure investments are coming, so each year most companies say capital expenditure will be pretty flat,” says Hodel. “This appeases investors, but to keep pace with competitors they usually end up spending more.”

Big spenders like AT&T and WorldCom have seen their stocks come under heavy pressure. AT&T’s stock price has tumbled from just over $50 in April to just under $20, and WorldCom’s price has dwindled from over $50 in January to around $15.

These companies will be under hard scrutiny from Wall Street next year, and that will have an effect on the way they spend. And a drought in the capital markets means access to capital will be hard for newer local phone companies like Covad Communications and NorthPoint Communications, Hodel notes: “The outlook is gloomy for these companies, and many that need more capital to build their businesses could go out of business or will be acquired.”

And it’s not just the technology sector that’s affected. Other U.S. companies are scaling back their expenditure for 2001, but in most cases not as drastically as the telcos says Boldin, who sees an increase in spending of between 5 percent and 10 percent next year in most sectors. “It was 15 percent not so long ago, and this is not sustainable now that the economy has slowed.”

So while it might be a well-recognized ploy for companies that woo investors by saying that spending will be flat, they might not be crying wolf in 2001 says Hodel. “There’s a lot of belt-tightening going on, so things will probably be different next year.”