Maturity Fast Approaching
By Jeanie Stokes
from the April 16, 2001 issue of Broadband Week
Flashback to 1997: The Telecommunications Act of 1996 has deregulated an industry and start-up companies are aching to challenge the Baby Bells for a bite of the monopolistic pie. To do so they need cash, and lots of it.
The solution: sell 10-year discount notes that let interest payments accrue for the first five years, before cash interest payments are required over the remaining five years.
Fast forward to 2002: It's time to ante up, folks.
Moody's Investors Service Inc., the big bond rating company, says the telecom industry is facing a difficult financial hurdle because the discount notes converting to cash interest payments is expected to spike in 2002 and 2003. That's going to boost the need for cash in an industry already stretched, in some cases to the bankruptcy courts, to pay its bills.
While the total amount of debt due over the next three years didn't look like a big problem for telecom companies, "in the discount note arena, we are seeing huge claims on cash coming that may not be serviced out of internally generated cash flows," says Marcus Jones, Moody's corporate finance analyst.
Interest from converting the discount notes to cash payment instruments will add $1.3 billion to other debt service due in 2003 from telecom providers, Jones says.
Telecom companies sold about $31 billion in speculative debt in the form of discount notes during the telecommunications industry's high yield boom of the late 1990s. That's about one-third of the total telecom indebtedness issued over the same time period.
In 1997, capital was cheap and there were plenty of investors eager to get in on what they saw as a huge opportunity in the new era of telecommunications. Wall Street had seen such CLECs as Teleport, MFS and Brooks Fiber acquired by investment grade companies such as WorldCom and AT&T, reaping big bucks for investors. They hoped lightning would strike again.
"It's a perfect instrument for a competitive local exchange carrier that's starting from scratch and needs a lot of cash. It gives you five years to get your act together," Jones says.
The problem, especially for the smaller telecom companies, is that profitability hasn't lived up to expectations. The huge capital outlays needed to build networks have maxed out their credit cards, and the lenders aren't raising their credit limits. If the businesses aren't generating enough cash flow to pay their debt service, they're faced with either refinancing their debt or selling more equity.
Given the tight money conditions that exist today, "the market for refinancing may not be there," Jones says. To match that peak in financing that occurred in 1997 and 1998, there needs to be a similar peak in capital availability. "That's not what we're seeing right now."
Jones compares the situation faced by the telecom industry today with that of the airlines after deregulation in the 1980s. A lot of new airlines were started and funded. Most either failed for a lack of money and went bankrupt, or were gobbled up by bigger competitors, who often paid fire-sale prices for their assets.
That's already beginning to happen. Digital subscriber line service wholesaler NorthPoint Communications filed for Chapter 11 bankruptcy in January and eventually agreed to sell its hard assets to AT&T Corp. for $135 million--about 27 percent of the $500 million NorthPoint said they were worth. AT&T didn't assume any of NorthPoint's $485 million in outstanding debt either, meaning those bondholders probably will be left high and dry.
To be sure, other analysts say the problem of not enough money to meet debt payments is even more acute. Former Lehman Brothers convertible bond strategist Ravi Suria, who recently moved to Duquesne Capital Management, says about 80 percent of the new economy telecom players are facing debt defaults over the next three years and will have to seek Chapter 11 bankruptcy reorganization. That means the debt holders will take over the companies, shareholders won't get anything and, after the restructuring, the companies will continue operating, but with little or no debt.
So how's the future likely to pan out? Wireless companies issued about half of the $31.4 billion in outstanding discount notes. For the most part, they "have proved their concept and are positioned well for the conversion of their discount notes to cash pay instruments," Moody's says.
It's more a mixed story for the CLECs, some of whom are faring well and have improved their credit ratings since they sold the debt. Others that haven't are in trouble.
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