Double Crossed

“There is no surer bet in the Telecosm…”

George Gilder
Speaking of shares of
Global Crossing
June 2001

Lower rates do good, bad or nothing at all…which?

Last week’s letters wondered. Rates have been near zero in Japan for more than 5 years. But instead of reviving, the country is still stuck in a deflationary mud hole.

Fighting against it, the Japanese seem to sink deeper.

Will lower short term interest rates – albeit delivered more quickly – do more for the world’s number one economy than they did for its runner up?

Perhaps not.

In support of this possibility we offer a brief look at one of the great stories of the recent boom.

Few people benefited more from the abundance of credit and easy terms of the late ’90s than Gary Winnick and his company, Global Crossing.

Winnick was a former Drexel Burnham bond trader who got into the optic fiber business almost by accident. He saw the possibilities of bandwidth after financing an undersea cable for AT&T in 1997. His first cable took 14 months to lay, but was extremely profitable.

Thus, did the simple business plan for Global Crossing emerge – raise money and lay fiber-optic cable!

The money was soon coming into the Hamilton, Bermuda, headquarters of Global Crossing at the speed of light. The stock went public in August 1998 at $9.50. Eight months later, it hit $60 a share…giving the company a market capitalization of $54 billion. Mr. Winnick’s personal stake in the company rose to $4.7 billion.

But last week, Global Crossing “shocked and angered” investors by reporting a loss of $3.35 billion, more than 6 times greater than the loss from the same quarter a year earlier. Included in the loss was a $2 billion write-down of its stake in another star-crossed company from the Gildered Age, Exodus Communications, now operating under protection of the U.S. bankruptcy code.

Global Crossing common traded at only $1.24 on Friday… up from the 38 cents rate of Oct. 9, but down from the $13.30 level set in June, when George Gilder believed it to be a sure thing.

In the last year and a half, investors have lost about $52.9 billion on the stock alone.

For the benefit of impatient readers, we will wonder at the end of this letter – as at its beginning – how lower rates of interest could spare investors this loss. Some sorts of pain, we recall writing, can’t be avoided… they must be endured.

“If you bought Global Crossing in 1998,” wrote New Era hallucinator George Gilder, as recently as last June, “you bought one 5,000-mile cable. Today you are buying a 102,000-mile network. If you bought Global Crossing in 1998, you bought $400 million in revenue. Today, you are buying over $5 billion in sales and more than a billion dollars in adjusted cash flow, growing at 40% a year. If you bought Global Crossing in 1998, you bought into static transatlantic STM-1 sales. Today you are buying an IP backbone with traffic growing at 450% a year and 20% ownership of Exodus, the Web’s key hub for exafloods of content, storage and services which almost doubled year-to-year revenues in the March quarter. If you bought Global Crossing in 1998, you bought the dream of a global web of glass and light. Today you are buying that web.”

The dream turned out to be a better investment than the web itself. As Global Crossing raised more and more money and laid more and more cable it hastened the moment of its comeuppance. Instead of Gilder’s “exaflood” of profitable content…the cable companies were soon swamped with excess supply…and were soon so deep underwater, financially, they had no hope of escape.

And while Gilder watched the stars of the Telecosm, smart industry insiders tuned their own eyes earthward and saw the deluge coming.

According to a report in Forbes, “[Winnick] and his family pocketed more than $600 million by cashing in stock over the past two years, even as Global Crossing struggled with a lethal debt load, falling prices, andan industry in turmoil. He also arranged to sell, for example, 10 million shares in May, at $12.”

“Good timing,” observes Forbes.

In addition to the stock market losses, Global Crossing’s burden includes a debt load of $6.7 billion.

But today’s investors are not the same warm-hearted, generous naifs who lent money to Global Crossing and other wunderkind at the height of the tech boom. Today’s lenders have marked Global Crossing’s bonds to a suspicious market at 18 cents on the dollar. Its secured bank debt trades at 67 cents on the dollar. Preferred shares are priced so low they should yield 177% – if they yield anything.

Together, lenders have losses of nearly $4 billion.

Bandwidth looked like a good investment when investors had a lot of money and little bandwidth. But now, investors have much bandwidth from which to choose and less money. Prices of bandwidth have plummeted.

Less than 10% of fiber-optic cable is used or “lit,” as they say. Adding more capacity at this stage is like opening another bottle of wine after you are already drunk.

Nevertheless, low rates and easy terms put billions in the hands of telecoms such as Global Crossing. The company “continues to burn through $500 million each quarter to fund more construction,” says Forbes, “despite the fiber glut.”

Lower rates may help Global Crossing on its binge a while longer. But does providing more of what people already have too much really make things better?

Your correspondent, wondering…

Bill Bonner
November 19, 2001

Mixed signals and confusion:

“Industry has been in recession for longer than at any time since the Great Depression of the 1930s,” says the Financial Times. Industrial production fell for the 13th month in a row in October.

Retail prices fell too, at an annual rate of 0.3% in October – falling faster than at any time in 15 years.

And the states are running out of money. “State Funds for Jobless Run Low on Slowdown,” says a Washington Post headline. “New York revenue plunge worse than depression rate,” adds the New York Post. And California governor Gray Davis has already cut billions from the budget as a result of lower-than-expected tax revenues.

But “listen to what the bond market has to say,” advises Eric Fry, below.

Well, long bonds spoke out in favor of inflation…falling the last 6 days in a row. What do bond investors see that we don’t? Has the Fed reached the end of its rate cuts? Is the economy about to rebound? Is deflation about to give way to inflation? If so, how come gold did not rise?

Home prices continued to climb last quarter – rising at a 6.6% annual rate. And an L.A. Times poll found most people still very optimistic about stocks and their personal finances. Conceding that the economy may be in recession, 74% were “confident” that the stock market will do well in the next 12 months. And 85% of fund managers, according to Merrill Lynch, are bullish.

What do you do when the picture is so muddled? You have to return to the essentials, dear reader. The idea is to buy low, sell high. Are stocks low? Nope. In fact, they’re very expensive – more expensive, by some measures, than they were at the peak in 1929.

And if you buy high…you are already off to a bad start.

Eric, what do you think?

*****

– The stock market put in another very satisfying performance last week. The Dow gained 259, or 2.7% over the five-day span and the Nasdaq advanced 3.8%.

– From all outward appearances, the old bear market has become a new bull market.

– Or maybe – and here’s where it gets tricky – we’ve just had a very typical “bear market rally.” So says Fred Hickey, editor of the High Tech Strategist.

– “To date, this bear market rally has been no different than the other rallies seen earlier this year,” says Hickey. “The Nasdaq started the year in January with a 25% barn burner before it collapsed in early April. An ensuing 43% April-to-mid-May party took the Nasdaq to over 2,300 and the Dow Jones Industrials to 11,350 before the summer’s slaughter. Each time the rallies failed, and the major indices fell to lower lows. Lower lows and lower highs were the patterns seen after the 1929-1932 U.S. stock market crash and the early 1990s’ Japanese stock market debacle.”

– Ah yes, there’s that familiar comparison to post- bubble Japan that we’ve been reading so much about lately. Certainly there are some similarities between the U.S. economy of today and that of post-bubble Japan. But the easy comparisons between the two may be just that – easy. Perhaps it is too easy to assume that the American post-bubble economy is somehow predestined to follow Japan’s into a deflationary abyss.

– The U.S. economy may well be facing a rugged decade ahead, just like the Japanese have endured. But it will not be a rugged deflationary decade.

– It’s true that inflationary pressures in the U.S. have been moderating for several months. Nevertheless, the CORE U.S. Consumer Price Index continues to rise more than 2% per year. By definition a rising CPI means prices are inflating, not deflating.

– Perhaps we should think of current trends as an inflation bear market – one that is almost over.

– Why? Mostly because the U.S. is not Japan any more than a Big Mac is sushi. But more about that in a moment. Bill has set up his tent in the deflation camp. I’ve parked my Winnebago in the inflation camp. (What is a mobile home, after all, but an “inflated” tent).

– But let’s be very clear, for the next three to six months, most visible trends will reflect deflation. After that inflationary trends will likely reassert themselves.

– Last week Bill wrote, “We have been boring readers for more than two years with our comparison of the U.S. bubble economy of the late ’90s to Japan’s bubble economy of the late ’80s. The parallels are obvious… both countries were admired worldwide for their new technology and business-management successes. Confidence inspired credit and borrowing…and led to huge increases in capacity in the leading industries as well as the amount of debt…And in both countries, the bubbles burst – with stocks down nearly a third in the following 18 months. Where do the parallel lines diverge?”

– I do not pretend to know the answer, but I’ll hazard a guess: Soon. Americans are not Japanese. We may both have professional baseball teams, but the similarity ends there. The remarkable thing is that our economic patterns would ever track a parallel course, not that they might at some point diverge.

– Just because two strangers happen to walk alongside one another for a block or two does not mean automatically that they will both eat sea bass for dinner that night and both watch monster truck races on TV before going to bed. They’re on the same sidewalk. That’s all. The rest of their lives will almost certainly not track a parallel course.

– There is one striking difference between the Japanese and the Americans, and that might be the only difference that matters: The Japanese save; Americans spend.

– Many market observers have pointed out that Greenspan has slashed interest rates far more swiftly and decisively then did the Bank of Japan in 1990, immediately after its bubble. Therefore, is it really such a surprise that the go-slow Bank of Japan, together with a cautious saving populace, produced deflationary conditions?

– By contrast, should we be surprised if an aggressively stimulative Federal Reserve, together with a populace predisposed to borrowing and spending whatever money it can possibly borrow and spend, produces inflationary conditions? Americans might suddenly become savers, of course. Senator Ted Kennedy might suddenly become a Republican. But if October car sales are any indication, Americans aren’t saving yet.

– The Fed is expanding the money supply at a very rapid clip. Some of this cash is finding a home in the stock market. Some is landing in the hands of consumers via home-equity loans. But wherever it lands, it will almost certainly stimulate credit and facilitate consumption. These two practices do not exactly cause inflation, but they are certainly inflation’s roommates.

– The Fed’s actions may or may not help to engineer a durable economic recovery. But the Fed’s actions will almost certainly reawaken Old Man Inflation by the second half of 2002.

– The bond market seems to think the old man is stirring already. The yield on the 10-year Treasury note vaulted from 4.31% to 4.85% in just one week – the largest weekly percentage jump in yields since the 10-year became a regular issue 25 years ago.

– So please don’t take my word for it on this whole inflation vs. deflation debate. Listen to what the bond market has to say. I will be.

*****

Back in Paris…

*** Okay, the bonds spoke. Okay, the core rate of inflation is still positive. Okay, consumers are still spending money and feeling bullish.

*** And, yes, the Japanese eat raw fish. But you don’t have to like sushi to want to save money and avoid insolvency…

More on this as the story unfolds…