Telecom Junk Bond Investors Shrug Off Latest Downgrades
By TOM BARKLEY
Of DOW JONES NEWSWIRES
NEW YORK -- Telecom junk bonds felt the sting Monday from the latest slap at the troubled sector, with bond prices falling in reaction to the credit downgrades late Friday of benchmark names Level 3 Communications Inc. (LVLT) and McLeodUSA Inc. (MCLD) into the lowest rating tier.
But investor reaction was fairly muted, with both companies' bonds losing only 2 or 3 cents on the dollar and remaining above their lows for the year.
In part, that's because the bonds were already trading at highly speculative levels, say market watchers. But it's also because of a growing belief that companies that are still standing after the rash of telecom bankruptcies already this year have a better chance of surviving the rest of the downturn.
"We think most of the major guys out there now that haven't filed (for bankruptcy) are going to be survivors," said Jerry Paul, portfolio manager for Invesco High-Yield Fund. "It's just a matter of getting the proper capital structures."
Paul cautions that it will take a year or two of operating success before the startup telecoms can prove that their business models work, but he sees it as a good sign that Level 3 has amended its credit agreement to allow it to swap debt for equity.
"That can wind up being a win-win situation for everybody, debt and equity investors, as long as they don't wait too long," he said, adding that if other telecoms follow Level 3's lead, a big part of the cloud hanging over the sector could be lifted.
That's not to say optimism abounds in the market, but investors have already priced in the risk that many companies in the high-yield telecom sector could default on their interest payments.
"Whenever you talk about liquidity, there is a risk of default," said Aryeh Bourkoff, analyst at UBS Warburg, who added the latest ratings are "dangerous," but don't imply certain bankruptcy.
Late Friday, Moody's Investors Service cut Level 3's senior unsecured rating to a highly speculative Caa1 from B3, saying it was concerned the long-haul carrier may not be able to generate enough returns to cover its network deployments costs in the longer term.
Level 3's 9.125% notes due 2008 fell to 55 Monday after trading as high as 57.5 Friday. They had climbed over 4 points at the end of last week after the company announced its debt-for-equity swap amendment on Thursday.
The bonds, yielding a whopping 21%, are trading much higher than their low of 35.5 - after Moody's put them on review at the end of June. Also around that time, Standard & Poor's cut the bonds to triple-C-plus from single-B.
A spokesman for Level 3 declined comment on the credit rating.
McLeod's senior unsecured debt was cut three notches to triple-C-plus from single-B-plus by S&P Friday, with the rating agency warning that the company's funding levels provide "little safety" against the risks in the challenging competitive local exchange carrier, or CLEC, sector, where McLeod and others compete with regional Baby Bells.
McLeod's 11.375% notes due 2009 fell Monday to 55 from 59 on Friday. But that's still higher than 52 in early July, when Moody's cut the notes to B3 from B1. They are yielding 24%.
Officials from McLeod couldn't immediately be reached for comment.
Bottom's Up?
An analyst said investors will continue to be concerned about whether telecom companies can fund their business plans during the difficult period characterized by overcapacity and a slowing economy, but he said companies such as Level 3 and McLeod have enough liquidity to weather the downturn.
"After the shakeout's through, perceptions regarding some of these companies will look different," the analyst said, adding that he thinks the bonds of Level 3, McLeod and some others in the sector have already bottomed.
Not so, perhaps, for everyone in the sector.
On Monday, S&P cut McLeod competitor Focal Communications Corp.'s (FCOM) senior unsecured debt to triple-C from single-B-minus, while keeping the credit on review for further possible downgrade due to concerns that the company could run out of cash by the end of the year. Moody's cut Focal's senior notes Friday to Caa3 from B3.
Focal said in May that it would be able to fund operations through the second quarter of next year, when it will need additional financing. But Moody's warned that the capital markets are broadly closed to CLECs and that private equity sponsors are unlikely to want to take a risk in the company.
Officials from Focal couldn't immediately be reached.
No trades were sighted in the company's 11.875% global senior notes due 2010 on Monday, but they were likely down a few points from Friday's level of 27, a trader said.
-By Tom Barkley, Dow Jones Newswires; 201-938-4385
tom.barkley@dowjones.com |
