What it means
The company was founded in 1997 with a bold plan to connect the world's major cities through a single high-speed network. It grew quickly, raised billions of dollars from investors and lenders, and saw its share price soar as investors believed demand for data would grow without limit.
The business model depended on selling or leasing capacity on the network to other carriers and corporations. Trouble came from two directions.
Many rivals built similar networks at the same time, which led to a glut of capacity, and the prices that could be charged for it fell steeply. At the same time, the company carried enormous debt, so falling revenue made it hard to cover interest and repayments.
Accounting practices also came under scrutiny. Like some other telecom firms of the time, the company swapped capacity with other carriers, and questions were raised about how those transactions were recorded and whether they gave a flattering picture of revenue.
The topic is a classic example of why analysts look closely at how revenue is recognised, and especially at deals where each side is both customer and supplier. The company entered Chapter 11 in January 2002, a process under US law that allows a business to reorganise its debts under court protection.
It emerged from the process and continued to operate, and it was acquired by Level 3 Communications in 2011. Shareholders who held the stock before the collapse lost almost everything.
The lessons are practical. Assess whether a growth story is backed by cash flow, check how much debt sits behind it, and be sceptical about revenue from transactions in which no real cash changes hands.
Those questions apply just as well to technology and infrastructure businesses today. The episode also changed behaviour afterwards.
Regulators and lawmakers tightened rules on corporate accounting and auditing in the early 2000s, and investors began to pay far more attention to cash flow and the quality of reported revenue. Many of the questions that analysts ask about technology and infrastructure companies were shaped by this era.
In practice
Real-world examples.
Example
An equity analyst reviews a telecom company whose revenue is growing at 40% a year but whose operating cash flow is negative. She treats the gap between reported revenue and cash as a red flag and values the shares much more cautiously.
Example
A bank lending to an infrastructure company asks whether demand for its capacity justifies the debt. The credit team models a fall in price per unit of capacity of 30% and finds that the interest cover (profit divided by interest) falls below the bank's minimum.
Example
A finance director of a data centre operator is offered a deal in which she buys capacity from a customer and sells a similar amount back. She asks whether the deal has commercial substance beyond improving reported revenue, and the auditors insist on disclosure.
Formula
Calculation
First-year profit boost from a capacity swap = Revenue recognised up front - First-year expense on the capacity acquired
These figures are hypothetical, to show why such swaps are scrutinised. Suppose two carriers each hand the other network capacity worth $100,000,000. Carrier A records $100,000,000 of revenue immediately, but treats the capacity it receives as an asset that is written off over 20 years. The yearly expense is $100,000,000 / 20 = $5,000,000. The first-year profit boost is $100,000,000 - $5,000,000 = $95,000,000, even though no cash was received. The effect depends entirely on the accounting treatment and can mislead anyone who looks only at reported profit.Case study
Seen in the real world.
Meridian Fibre Networks is an illustrative, fictional company, loosely inspired by the telecom boom but not based on any real firm. It borrowed $2,000,000,000 to lay cable across several continents, assuming that demand for data capacity would double every year.
Rivals built rival routes, and the price that Meridian could charge for capacity fell by half in two years. Annual revenue stalled at $400,000,000, while interest on its debt was $240,000,000, which left very little to cover running costs and further investment.
The company sought court protection and its lenders took control. The illustrative lesson is that heavy borrowing against a forecast of limitless growth leaves no room for error when prices fall. With revenue of only 1.7 times its interest bill ($400,000,000 divided by $240,000,000), and operating costs still to be paid out of that revenue, there was no cushion at all.
Watch out
Common mistakes.
- Assuming that rapid revenue growth means a healthy business, when cash flow and debt levels tell a different story.
- Ignoring who the customers are, when revenue from deals in which both sides trade with each other may not represent real demand.
- Believing that bankruptcy always means a company disappears, when a Chapter 11 case can allow it to reorganise and carry on.
Questions
People also ask.
When did Global Crossing file for bankruptcy?
It filed for Chapter 11 protection in January 2002, and it was one of the largest corporate bankruptcies of its time.
What happened to the company afterwards?
It emerged from reorganisation and continued as a network operator until it was acquired by Level 3 Communications in 2011.
What is the main lesson for finance professionals?
Check cash flow and debt as well as reported profit, and be sceptical of revenue from transactions that look circular.
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