Let others wait for the Next Big Thing. In the world of bankruptcy, they wait for the Next Big Meltdown.

Perhaps a combination of foreign competition and high energy costs will tear the domestic paper industry to shreds. Or maybe the end of the housing boom will kick the legs out from under construction and home-remodeling companies.

Perhaps a combination of foreign competition and high energy costs will tear the domestic paper industry to shreds. Or maybe the end of the housing boom will kick the legs out from under construction and home-remodeling companies.

They've analyzed the ratings assigned to the $20 billion-plus worth of high-yield bonds issued by more then three dozen telecom companies since the start of 2002. Their work suggests that these companies are at especially high risk of defaulting on their obligations in coming years.

The issuers fall into a handful of camps: rural telephone companies; cellular phone companies; competitive local exchange carriers (CLECs) that provide telephone and data service to businesses and some residents in major cities; and long-haul carriers that carry Internet and phone traffic over long distances.

Miller Mathis Managing Director H. Sean Mathis, speaking during a presentation this summer, noted that 43 percent of the high-yield bonds issued by these companies from 2002 to 2004 were rated CCC+ and below at issuance.

According to its ratings guidelines, Standard & Poor's viewed those obligations as "currently vulnerable to nonpayment," and "dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment."

Other research, said Mathis, shows that over time, 47 percent of bonds rated CCC+ and below at issuance default within five years - hardly a distinguished track record.

Nevertheless, a close look at the companies that issued these high-yield bonds suggests that we're not likely to see anything like the telecom meltdown of 2000 and 2001. Many of the companies that issued them did so as part of restructurings in which they survived intact.

These survivors often emerged with cleaner balance sheets, sound business plans, and talented management teams (although their levels of leverage still give ratings agencies pause). In addition, the telecom meltdown was followed by a wave of consolidation. As a result, the survivors face less competition and command more pricing power than telecom companies of that earlier period.

Carlyn Taylor, senior managing director at FTI Consulting, an Annapolis, Md., consulting firm that has done a great deal of telecom restructuring work, said that back in the late 1990s her firm identified some 400 CLECs with at least $50 million in assets or funding. Today, Taylor said, just three dozen significant CLECs remain. At least a third of those she'd describe as "well-run" companies with positive free cash flow.

Time Warner Telecom Inc., of Littleton, Colo., does not generate positive free cash flow. But of those CLECs with outstanding high-yield bonds it ranks as one of the highest rated at Moody's Investors Service, according to Gerald Granovsky, a senior analyst.

Last year the company, which provides data, local and long-distance voice service to business customers in 44 cities, generated $213.5 million in modified EBITDA, a metric used by telecom analysts to tell how well a company is doing at generating cash to meet debt and other obligations.

The company merits a B2 corporate family rating from Moody's - a middling rating for a speculative-grade issuer. But Moody's also recently changed its outlook on Time Warner Telecom from negative to stable, citing in part the company's ability to grow EBITDA margins by winning over corporate customers.

To be sure, the telecom market is a difficult place for Time Warner Telecom and others to make money. The industry remains under the thumb of the Federal Communications Commission, whose decisions can throw whole sectors of the industry into disarray.

Despite a measure of consolidation, competition remains rampant: cable TV companies, Internet service providers and cellular companies are all chasing after local and long-distance phone customers, while phone companies are returning the favor by going aggressively after Internet and video customers. The battles continue to push down the prices service providers can charge. They also raise the cost of attracting and keeping customers.

Still, the late 1990s may well prove to be a unique time in telecom history. Anticipating growing use of the Internet and other high-bandwidth services, telecom executives of that era, cheered on by Wall Street, raised billions of dollars to build vast networks of fiber-optic cable. But, as we now know, projections for Internet traffic proved too optimistic, and advances in routing equipment produced sharp increases in the capacity of networks already installed.

In the end, some 45 percent of telecom companies that issued high-yield bonds from 1998 to 2001 wound up defaulting on those obligations by the start of 2004, according to Miller Mathis; many of the companies folded, leading to painful losses for senior lenders.

"I believe we'll continue to see defaults," said FTI Consulting's Taylor, "but not defaults where we see massive wipeouts of the debt." Her take on the telecom meltdown of 2000 to 2001: "That was truly extraordinary, and won't happen again." DBR

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