Rough Crossing for Global Crossing
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GWEN IFILL: And joining us to discuss Global Crossing and the remarkable resemblance its successes and failures bear to the Enron experience, are Rob Frieden, Professor of Telecommunications at Penn State University; and Susan Kalla, senior telecom analyst at Friedman, Billings and Ramsey, a brokerage firm based on the East Coast. Welcome, so, Rob Frieden, what caused the fiber optic industry to collapse? That is the basic underlying question here.
ROB FRIEDEN: Yes, well, I think the first point emphasize is that we have a glut of fiber optic capacity in various ocean regions and there is a lot of cable capacity that has not yet been activated but as well needs to be used before we get out of this glut.
GWEN IFILL: Susan Kalla, we just heard Joseph from Arthur Andersen say the business was not succeeding, and that was what the problem was at Global Crossing. Is that what happened?
SUSAN KALLA: Well, I believe after the Telecom Act was rewritten in 1996, there was a lot of euphoria in the business. It was when the Internet was just taking off and so much money flowed into the business, so much capital from Wall Street. $500 billion flowed into the business between 1997 and 1999. And with all of this money, an array of different competitors start to build out global networks, in a race to be the first one to finish and they started finishing them out, finishing out their global networks in the early 2000. And when those networks were lit, suddenly there was way more capacity than anyone could anticipate using. And the prices started to just plummet. And in 2000, in the year 2000, prices for transatlantic minutes of use declined by 60%. And in 2001, prices in the wholesale market declined 90%.
GWEN IFILL: Now, Professor Frieden that is interesting, that’s how the business part of this failed. Was there anything — is there anything to be learned from what we learned from Enron about the way managers there managed the business, which also brought it to the brink, or brought it to bankruptcy?
ROB FRIEDEN: Yes, there was a real gold rush mentality and a real emphasize on doing deals and the excitement of swapping capacity and the press releases that would herald multimillion dollar — hundred dollars million dollar deals.
GWEN IFILL: I have to interrupt you. You said swapping capacity. What is that exactly?
ROB FRIEDEN: Well, typically a company is going to have an investment in a submarine cable in one ocean region, it may want to develop a one stop shop offering of capacity throughout the globe. Global Crossing is one of the companies that had capacity in a lot of ocean regions but still companies typically want to calibrate their inventory and that means that Global Crossing may have wanted to swap some of its Atlantic capacity for Pacific capacity.
GWEN IFILL: Whether, indeed, that actually existed or not in terms of in a business sense.
ROB FRIEDEN: Yes, and further to this point about a gold rush mentality, and the emphasis on the deal, the real question got down to how do you go about booking this investment? How do you go about declaring present revenues as opposed to future revenue? Many of these cables have a useable life of tens of years. And a deal might provide for a cash payment, but then you have to sort of advertise or spread that payment over the life of the cable. A press release might herald $100 million investment or purchase of capacity but it might be ten million dollars in each of ten years.
GWEN IFILL: Miss Kalla, let’s talk some more about this gold rush mentality. There were reports of $10 million signing bonuses and $3 million severance packages for people who weren’t even leaving the company. Was this aggressively — were they being aggressively optimistic about the potential for net gain here or were they bordering on fraud?
SUSAN KALLA: Well, that’s for the courts to decide. It’s — what they tried to do was to build out the networks as quickly as they possibly could and then put on revenues as quickly as they possibly could. And for — some of the allegations surround how they booked those revenues; if the revenues for a long-term contract, a 20-year contract were booked, they would sometimes take the entire amount up front. And the, they put the revenues on the operating performance and they put the expenses on the balance sheet if they did a swap then they counted those expenses as capital improvements. So if they did a swap, they would in essence just give you the revenue side and because there was no expenses associated with them, sometimes they would flow straight down to the profitability line. And it looked like greater profits than possibly should have if you were using a more conservative accounting mechanism.
GWEN IFILL: Now, we have heard, continue with you Miss Kalla, about Kenneth Lay at Enron putting a face on that, the management of that company. What about Gary Winnick? Tell us about him.
SUSAN KALLA: Well, Gary Winnick was new to the telecom industry. I’ve spent a long time in telecomm and didn’t know him until he entered into the business in 1997. So he was brand new, and he was actually from the banking community and the telecom industry is a very highly technical business. It’s — the sales are very large. It’s a very capital-intensive business. It’s in fact a very difficult business to become profitable in. It’s a very difficult business to make a sale in. Some of the telecom organizations I’ve worked for, it takes two to three years to close a deal for 40 million dollars.
GWEN IFILL: And was that not happening with the Global Crossing, it wasn’t taking that long?
SUSAN KALLA: Gary was able to close deals much faster. He was able to increase sales by $500 million in one year, another $500 million in another year and then a couple of billion in one year. And he was able to do that in a one-year period. That was very unusual.
GWEN IFILL: Professor Frieden, we know it was unusual, but do we what whether what he was doing or what any of his deputies were doing was illegal?
ROB FRIEDEN: Well, I would say the thing to emphasize is they first executed on a business plan to develop an infrastructure globally and the real question gets down to when is that capacity going to get used up and quite frankly, they failed to generate enough present revenue to make the business a going concern, but in the longer run the capacity is going to be consumed right here on the Penn State Campus, we have students who are clamoring for more bandwidth. Admittedly, they may be not paying for it at a market price, but it is going to take a lot more than just e-mail type applications, and here at Penn State the students are sending files, video files and music files. If indeed we are a sort of hot bed or test bed, the future looks very, very good indeed for slowly but surely consuming this capacity.
GWEN IFILL: Well, Global Crossing was not a slowly but surely business, was it?
ROB FRIEDEN: No, and they were very much encouraged to borrow money. They were making great progress. But quite frankly in the short-term they weren’t generating enough money and there was such a downturn in the price of this capacity that they ultimately couldn’t pay the debt that they amassed.
GWEN IFILL: Miss Kalla, this isn’t just about Global Crossing is it? The entire fiber optic industry is struggling with the challenges which you’ve laid out, what does it take for them to recover, or is it just as the professor said just waiting for the demand to meet the supply?
SUSAN KALLA: Well, the bottleneck in the whole network is really now at the local end. It’s to the home and to the business. Only about o 10% of office buildings are connected to fiber optics. Most offices, small businesses, and residences are connected still by copper. That is a very slow, speed transmission service compared with what fiber optic can bring. So in the local area you have very narrow pipes but in the long distance area where it’s a competitive business there is huge pipes. So as soon as you can blow through the local pipes, you’ll be able to access the long distance pipe and you’ll fill it up.
GWEN IFILL: Were the accounting and other practices at Global Crossing apparently engaged in, is that widespread in the fiber optic industry, can we expect to hear of over Global Crossings in the coming months?
SUSAN KALLA: It’s very common in the beginning of a network build for carriers to get together and to agree to some kind of division of labor. So each different carrier that’s involved in the business builds out one segment of a fiber optic ring that goes nationally or globally. That is very common. The questions that have arised are after the networks were mostly built out, 80 to 90% built out, the swaps continued. There is some question as to whether those, those swaps were necessary or those purchases of additional capacity were necessary. And that is really a function of what the carrier was trying to bid out, what kind of contract they had, what kind of service levels they were guaranteeing. So that is going to take some time to sort out.
GWEN IFILL: Professor Frieden, if one is a share holder of Global Crossing or of Enron for that matter and you have seen the stock price drop from $60 to 7 cents now — what happens to that money? Is there any way if a company goes into bankruptcy protection that that money or that investment is retrievable?
ROB FRIEDEN: I’m not saying when the shareholders who are very much at the bottom of the totem pole are going to be able to recoup much of anything. There are secured instrument holders who have a higher priority in terms of recouping what revenues Global Crossing and other companies in bankruptcy are going to generate. I think when Global Crossing is liquidated at pennies on the dollar, perhaps the acquiring company is going to have a successful going concern but the shareholders themselves aren’t going to be able to hang in there and aren’t legally entitled to acquire the upside that in the longer run is going to possibly be generated.
GWEN IFILL: Okay. Thank you very much Rob Frieden and Susan Kalla, thank you very much for joining us.
SUSAN KALLA: Thank you.
ROB FRIEDEN: Thank you.