Writing Down the Network
By: Peter Mueller, VP - Switching Technologies - ATS 

In this age of failed corporate mergers, we’ve become accustomed to post-merger announcements of write-downs – that miserable term used to quantify just how little goodwill, synergy, and operational efficiencies actually came from the merger of two companies.  

Companies do this because their balance sheets need to be calibrated every so often. Further, it’s the only way an acquirer can justify paying more for a target than that company’s so-called “book value.”  In other words, when you pay more for a company than its net value (assets minus liabilities), you justify it by paying for a non-tangible asset euphemistically called “goodwill.”  AOL and Time Warner are now feeling the pain of having to explain that there was no goodwill, and are adjusting their books accordingly. 

But what about our industry’s so-called “hard” assets – switches, routers and the like?  Do they ever get written down as goodwill?  Well, the answer is yes – usually through planned depreciation.  But one company, WorldCom, is feeling the pinch and their ordeal could have an impact on the rest of us. 

According to a recent New York Times article (dated 3/17/03), WorldCom’s bankruptcy ordeal required the company to re-value both their hard and soft assets.  After reviewing the books, WorldCom indicated they would write-down the value of its assets by $80 billion, of which $45 billion was for goodwill, largely a result of overpayment for acquisitions.  But what really made jaws drop was the company’s announcement that they were writing off more than $35 billion from their property, plant and equipment (hard assets)!  The new value of PP&E (Property, Plant, and Equipment) is now worth a vastly diminished $10 billion.   In other words, every $1 that WorldCom paid for its hard assets a few years ago is now deemed to be worth a mere 25 cents. To make matters worse, that $1 was never an accounting trick – it was really paid out in cold, hard cash to the likes of Lucent and Nortel.  A few years later, that buck is worth a quarter. 

What’s coming is a reckoning for all telephone companies. 

Not everyone will have to lop off 80% of their hard assets as WorldCom did, but some suggest that a number like 40% isn’t out of the question.  As one telecom analyst said, “It clearly shows that the remaining companies’ true economic value is well, well below where their book values are, even for hard assets and forgetting the goodwill…and if the true economic value is far below that, then stock prices will likely come down.” 

Is there any good news in all of this?  Well, sort of… 

One of a company’s most telling financial ratios is Return on Assets (ROA).  By dividing net income by total assets, you get a good measure of how well management can use assets to crank out profit.  (Think of a lemonade stand:  How well does Johnny use his blenders – hard assets – to make a profit?  His brother Jimmy might be making more money, but it might have taken more capital expense and more blenders to get him there – not as impressive.  (In telecom today, the banks aren’t funding blenders or switches!)  So here’s the good news:  In today’s environment, telephone companies showing any sort of profit really are seeing a higher ROA than previous times. 

It also means that companies are finding a renewed focus on their bottom line, and ROA in particular.  If your switch is “leaking” revenue (to use a revenue assurance term), it’s a much wiser use of time and energy to plug that leak than to go and invest in new hard assets.  Indeed, our switch audit customers have all committed themselves to the achieving the highest ROAs in the industry, and they are succeeding by focusing on ensuring that their switches are operating at peak performance. 

In future columns, we’ll look at specific instances of these “leaks,” and their impact on your bottom line. 

I’m interested in your feedback! 

• Are WorldCom’s woes too much of an industry anomaly?  What do you think of the claim made by analysts that hard assets are currently overvalued on most books? 

• Is ROA over or underrated?  What types of procedures are you putting in place to maximize ROA?

• What impact will adjusted assets have on the prospects of equipment vendors such as Nortel and Lucent?  Also, will this delay or speed up the deployment of next generation networks?

Write me at:

pmueller@atso.com

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