Bankruptcy Heads Ups
Just a mention likely means bankruptcy protection
By Jeanie Stokes
from the May 21, 2001 issue of Broadband Week
When a company starts using the "B" word--yes, we're talking bankruptcy--it's time to take that company at its word. While not every troubled enterprise wants to talk about the possibility that it may have to seek bankruptcy court protection from creditors, it's becoming increasingly common for such outfits to preview their worst-case scenarios to the world.
Winstar Communications Inc. raised more than a few eyebrows April 16 with a news release that it was considering a bankruptcy filing. Two days later, the New York-based competitive local exchange carrier filed for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code.
Winstar's statement was triggered by its failure to make $75 million in debt interest payments and by a dispute with one of its primary sources of vendor financing, Lucent Technologies, over whether Winstar was in default on its credit facility. The financial problems were such that Winstar is late filing its annual 10-K report to the Securities and Exchange Commission.
Those are deemed "material issues" in SEC lingo--events affecting a company's business. That's the kind of news regulators expect companies to disclose publicly in their routine or extraordinary filings.
Often such disclosures reveal that a troubled company has gotten a warning from its auditors that it may not be able to remain in business--a so-called "going concern" letter--that might presage an eventual bankruptcy filing.
But disclosing a possible move to the bankruptcy courts ahead of time is unusual. It's a step some publicly traded companies do only when their hand has been forced.
"There's been a series of materially negative events that have happened to them from a liquidity standpoint and they would rather say 'we may be forced to go Chapter 11' than get it out in the press and they are then forced to respond to it," says Rich Valera, technology analyst at Needham & Co. "If a company suggests they may go Chapter. 11, there's probably a fairly high probability that they end up doing that."
The Wall Street rumor mill today also may play a part. Speculation about a possible bankruptcy, just as with a rumored merger or acquisition, may make some sort of statement necessary.
"If they have an analyst following and are talking to the (analysts) and deem that information to be material, they need to say that to the world," says Louis Thompson, president and chief executive officer of the National Investor Relations Institute.
Company bankruptcies no longer appear to carry the stigma that they once did. Merrill Lynch analysts expect about half of the 35 or so publicly traded CLECs or data local exchange carriers (DLECs) to seek bankruptcy protection due to billions of dollars in debt they borrowed, but can't repay.
Not all of them are going out of business, though. Bankruptcy "can be a useful tool for a company that has a good business and a lot of debt," says Paul Hilton, managing partner of the Denver office of Brobeck, Phleger & Harrison LLP, a law firm specializing in business and securities issues for technology companies. It allows a company with a lot of debt to continue operating, without necessarily repaying its creditors. It also gives a company time to see if it can arrange an orderly sale or come up with a business plan that will work if it can get out from under the debt load.
Still, there's plenty of reluctance to raise the specter of bankruptcy openly. Some companies try to do business as usual until the end: DSL provider Pathnet Telecommunications Inc., for example, was announcing new market launches right up until four days before it filed for Chapter 11 protection on April 2.
In a bankruptcy restructuring of a viable business, it's usually the secured debt holders such as banks that take over the reorganized company. Unsecured creditors and stockholders usually lose their investments.
The down side to bankruptcies is the price of future borrowings through the sale of so-called junk bonds goes up. That's exactly what's happened in recent months as more telecommunications companies have reported they're in financial distress. The spread, or difference between what junk bond sellers must pay in interest versus that on government securities, has soared because investors today perceive telecom debt carries a greater risk.
"The more bankruptcies you see keeps pushing the spread up and contributes to a downward spiral (in available capital)," Valera says.
For even relatively healthy companies, having to pay 17 percent interest is creating crushing annual interest payments.
"If they could be paying 10 percent instead of paying a 17 percent yield, they'd have a much better shot at being able to refinance their debt. In this case, the markets are saying there's no price at which we would issue you more debt," Valera says.
Privately held companies, or companies that have publicly traded debt but no public equity, aren't subject to the same disclosure requirements as public equity companies, Hilton says. They do have an obligation to keep their investors, including venture capitalists informed, though.
"The one thing investors hate is surprise. It's critical to keep investors and board members informed," Hilton says.
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