Where Does the Money Go?

By: Chad Hudson | Wed, Feb 27, 2002
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This week has seen the usual amount of mixed data. First we learn existing home sales set a record in January, and then new home sales dropped to the lowest rate in over a year.

Consumer confidence came in lower than expected, but Greenspan said the economy is "close to a turning point."

Retailers have starting reporting earnings for their fourth quarter and honestly have been stronger than I anticipated. I plan on discussing the retailers next week, so I'll save comments until then.

GM slightly increased vehicle production estimates and guided its earnings for the year up by 15%. GM also forecasts that cost cutting and improving sales volumes would bring earnings to $10 per share by 2005. With analyst calling for EPS of $3.41 this year and almost $5.00 for 2003, GM really needs to kick in the growth drivers for earnings to double in just two years after 2003.

The latest Manpower survey indicates that hiring will start to pick up during the second quarter, although not at a significant enough level to signal the end of the recession. Twenty-one percent of firms surveyed anticipate adding staff, while 10% plan to reduce their workforce, compared to an equal number of firms, sixteen percent, planning to cutback and increase staff in the first quarter. This was the "first improvement in hiring intentions in more than a year." However, after seasonal adjustment this represents only a 1% increase in hiring for the second quarter compared to the first quarter. All sectors plan to add more workers than they plan to layoff, but frankly durable good manufacturing has been the only sector to indicate net reductions of workers in the surveys during 2001.

The back-drop of the Enron scandal continues to plague the market. Maybe not directly anymore, but the mindset of investors has been permanently altered. Individual investors are starting to get fed up with Wall Street. A recent Business Week poll indicated that 54% of investors worried that the information they get is not honest and reliable. 68% have little or no faith that the market treats average investors fairly. There is the very real chance that the masses of individual investors that were lured into the stock market will leave it now; creating more headwinds for the market, and making it tougher to achieve even normal returns over the next several years.

The World Insurance Forum was held in Bermuda last weekend. Not surprisingly, Enron and September 11 dominated the topics. The Financial Times published a story about the meeting. Jacques Blondeau, CEO of SCOR, a French reinsurer, pointed out that it was common knowledge that the insurance industry used offshore vehicles to alter their reserve requirements. In fact, he questions if there is an Enron among the insurance industry since "Enron used all the tricks, which may have been all legal, at its disposal. Everyone knows that insurers use all the tricks too." While a lot of analysts and pundits would like everyone to believe Enron was an isolated case, here is a CEO of a large reinsurance company saying his whole industry plays the accounting tricks.

James Greenwood, chair of the House Committee on Energy and Commerce's Subcommittee on Oversight and Investigation, thinks there could be "dozens" of other firms that are misleading investors about their financial results. He "also subscribe[s] to the cockroach theory that if you see on scuttling across the floor, there are probably others under the baseboard."

Banks continue to tighten credit standards in the wake of the commercial paper market seizing up. Banks are tightening credit several different ways; loan covenants are being tightened, protective features such as ratings-based triggers are being added, and credit line amounts cut. This will be another headwind the markets and the economy will have to overcome for any meaningful recovery in capital investment to take hold.

The banks are not feeling too comfortable facing the prospect that companies will draw down their credit lines at the same time. The banks set-up the credit lines with the "mentality that the back-up facility was never going to be used," according to Tom Okel, head of corporate syndicated capital markets at Bank of America. "Now back-ups are being structured for downside risk." This week, Gap had its unsecured facility replaced by a secured one. Consequently, Gap now plans a convertible bond issue to raise $1 billion.

On a smaller scale that is typical across the country, banks are reducing loans to small business and raising interest rates. Today, the Wall Street Journal carried a story discussing the situation a CEO of a small manufacturing company had after the company lost money in just one quarter. He faced a $75,000 penalty and the interest rate was hiked 300 basis points. He ended up finding a different bank with better terms but reduced the amount of the loan. The company will end up only spending about $1.5 million on capital improvements, compared to the $4 million to $5 million it normally spends. A survey taken by the National Association of Manufactures found that 34% of small- to medium-sized companies are having a harder time getting credit, with only 6% saying it was easier.

Here's a stat for you. According to Deutsche Bank Alex Brown, the world's seven biggest telecom equipment makers missed their initial 2001 revenue targets by a cumulative $60 billion. Which by the way is about the same amount JDS Uniphase wrote down after its acquisition of SDI two years ago. There are other huge write offs coming later. Stern Stewart & Company, calculates that WorldCom will have to eliminate $37 billion in goodwill, and Qwest will add about $22 billion to the write off gods. It is just me, or is everyone numbed by the magnitude and scope of the write downs and revenue declines?

Earlier this month, Merrill Lynch's The Telecommunicator, analyst Adam Quinton, detailed last year's capital expenditures for telecom companies and estimates for 2002 and 2003. Overall the outlook is bleak. Total capital expenditure for the industry is expected to decline by 26% in 2001, and decline another 7% in 2003 (What about the "V"). Capital spending by wireless providers is expected to be the only category to increase spending. The increase is mostly due to Cingular Wireless increasing its spending by 61%. Merrill expects Cingular to increase spending by $2.078 billion with the whole wireless category only increasing spending by $2.080 billion. CLECs (Competitive Local Exchange Carriers) are actually expected to be the only bright spot in 2003. Everyone should be reminded this will come after two horrible years. Capital spending declined 40% last year and is expected to decline 61% this year. In 2000, CLECs spent almost $11 billion on capx. Merrill expects it to bottom out this year at $2.6 billion, and then increase by 1.2% in 2003. And this will be the bright spot in the telecom industry. Here is a table of historical capital spending along with Merrill Lynch's estimates.

(in millions $) 1999 2000 2001 2002 Est. 2003 Est.
Full Service 54,851 64,662 60,956 47,518 45,670
Long Haul 8,450 18,399 12,782 3,287 2,594
CLECs 6,045 10,960 6,565 2,554 2,584
Wireless 12,269 17,737 21,441 23,521 20,991
Internet 1,720 4,479 2,334 688 688
TOTAL 83,336 116,236 104,078 77,568 72,527

The carnage in the CLEC space has been well documented, but here is a quick side note. Winstar, a CLEC that went bankrupt, was purchased for $42.5 million. Winstar had $5 billion worth of assets on its books, and just last year spent $163 million on capx. In March of 2000, Winstar had an equity value over $5 billion.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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