Bear mentality lumps liquid telecoms with losers, says Mason Street's Collins

By Paul A. Harris

St. Louis, Mo., July 2 - Amid considerable pain for investors, many market observers say telecom companies now face a wave of consolidation. And riding that wave will be all the more challenging as the capital markets are said to be largely closed to telecom.

Given these circumstances Prospect News asked Tim Collins, co-manager along with Steve Swanson of Northwestern Mutual's Mason Street High Yield Fund, how consolidation is likely to proceed, and how the post-consolidation telecom landscape is likely to appear.

"Many of the businesses in some of these sectors are natural monopolies," Collins said. "They seem to have relatively high fixed costs and relatively low variable costs. More than most industrial companies that makes it attractive for them to essentially eliminate competition by merging with it, and to reduce redundant overhead through consolidation.

"Right now the market really isn't offering up big buckets of new equity or new borrowing capacity for these companies, however," Collins conceded.

"I think you're going to end up with basically two groups of companies going forward: the haves and have-nots, relative to their liquidity.

"People that have cash flow have a degree of control over their own destiny as long as they don't experience a catastrophic drop-off in their operating results. The companies that have been inadequately or incompletely funded, on the other hand, are going to find themselves in situations where they're going to get squeezed by their competition encroaching on their business territories. They're probably going to find themselves sellers in a buyer's market. That's probably not going to be good news for some of their shareholders."

Collins said that although share prices and bond prices throughout the telecom sector are likely furnishing executives with acute cases of "sticker shock," management needs to focus on "relative" values, and take into consideration the circumstances in which they currently are operating.

"Executives at different telecom and media and cable companies are sitting there looking at their screens, and they're seeing a stock price that's a fraction of what they've become accustomed to just a short time ago," he said.

"Right now you have a 'falling knife' sort of market where people have not gotten used to where their securities are trading. But frankly with the kinds of dislocations that you've had you can make an argument that the exchange ratio on a stock swap for some would-be acquirers may have actually gotten more attractive, even if their stocks have dropped, because the people they are going to be acquiring have dropped by a larger percentage than their own. It's a relative situation.

"So if you have a funded business plan, as I think you can argue that a number of the investment-grade companies do, it's a pretty good opportunity to go shopping and roll up some of your smaller competitors."

One key element required to set the stage for meaningful consolidation to get underway, Collins said, is a leveling-off in the capital markets, in which they trade at the same level over a period of time.

He also said that since acquisition strategies are at the heart of some recent headline-hogging financial scandals, executives can be expected to proceed gingerly into any ensuing buying sprees.

"Many of the accounting scandals and difficulties you're experiencing in the markets right now generally stem from some companies that have pursued aggressive growth and acquisition strategies and accounted for them perhaps a bit too aggressively - or perhaps a lot too aggressively" Collins said.

"A lot of people are experiencing pain because of failed acquisition strategies. So even though consolidation is the logical strategy to pursue in some of these sectors, there's a little reluctance to be the first guy to stick his head out of the foxhole and make a major acquisition because you're not sure how the capital markets are going to react."

The Mason Street High Yield fund manager said that to a significant extent decent credits in comparatively healthy segments of the telecom sector are suffering from a bear market psychology that is creating an understandable reluctance on the part of both the buy and sell sides to draw meaningful distinctions among credits.

"Last year was the year of the wireline debacle," Collins offered as an example. "That sort of washed out and there has been a lot of pain but it's pretty well identified. This year it's been more of a wireless debacle. You have a lot of wireless companies out there getting whipped, I think, because they suffer from the misfortune of being covered by a lot of the same people on the buy and sell sides who follow wireline.

"I think you can make a good argument that wireless is a different business than wireline," he continued. "Most of the participants in wireless, even the startups, are actually generating cash flow, whereas most of the startup wireline companies never achieved EBITDA-positive. You can make a pretty good argument that (wireless) business plans are less capital intensive, and that there is an identified consumer demand for the product. People have legitimate differences over what they think the incremental growth will be going forward, but there's no question that there is a demand for the service and it's growing.

"And finally the physics are different. There's a finite amount of spectrum, a finite amount of carriage ability on these national networks. Basically the physics of wireline were such for all intents and purposes you had unlimited supply. That's just not the case with wireless. So I think that segment is less vulnerable - but perhaps not immune to - this ruinous race to the bottom pricing dynamics than what you experienced before, in wireline."

The bear market mentality against which the wireless credits are presently struggling, Collins said, is an almost exact inversion of the dynamics that prevailed in the bull market approximately two years ago.

"Sometimes in a bear market a little of the reverse psychology can take hold," he explained. "Sometimes in the absence of credit news bonds and stocks are just down because the psychology's bad and they were down yesterday.

"Ultimately you have to drill down," he continued.

"If you were marking up dot-coms a couple of years ago it turned out that perhaps there wasn't much value beneath you even though you were marking up your position every day.

"Just because you're marking down your position every day in some of these areas like cable or utilities or the energy sector, or even in the wireless sector, it isn't a foregone conclusion that the ultimate value has been destroyed."

As to what lies beyond the wave of consolidation about to break over the telecom sector, Collins said, much will depend upon which companies possess the liquidity to get past the present economic downturn.

"A lot of the companies that have failed over the past couple of years have taken what I'll call a 'bull market strategy,' with an upward-sloping yield curve.

"It's very profitable to finance the creation of long-term return-generating assets with short-term cheaper money. The problem with that sort of funding strategy - and I think it's been particularly prevalent with a lot of the investment-grade companies that have been becoming fallen angels - is that it's great and it's profitable as long as the market is going your way. But if you encounter some adversity or some loss of confidence all of the sudden you hit an immediate funding or liquidity crisis because you don't have your funding locked in longer term, with longer term bonding, with term loans and with equity. What you have is a lot of short-term maturities.

"I think the $64,000 question for some of these companies is maybe not whether or not they're going to be able to come out the other end with an enterprise that has a value of X or Y or Z, it's whether or not their stakeholders, in the form of their equity-holders or their bondholders, are going to live long enough to get from point A to point B, or whether they're going to have to restructure along the way."

Collins declined to comment on specific credits in the telecom sector citing company policy.

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