Bondholders Press Telecoms To Halt the Spending Sprees
By MITCHELL PACELLE and SHAWN YOUNG
Staff Reporters of THE WALL STREET JOURNAL
As "cash burn" rates go, Rhythms NetConnections Inc. stoked up a bonfire, spending an estimated $1.9 million a day more than it took in from customers during the first quarter. In the process, the Englewood, Colo., provider of high-speed Internet access lit the fuse of bondholders.
Bondholders want to stop the cash drain now, while some cash and liquid assets are left. It won't be easy. Rhythms hasn't defaulted on its $839 million in junk, or high-yield, bonds, the traditional trigger for bondholders to begin issuing demands to management. And as of March 31, Rhythms had $404 million of cash and liquid assets. Bondholders have hired financial adviser Jefferies Group Inc. to press their claims anyway.
All across the telecommunications landscape, holders of junk bonds are watching with alarm as weakened companies continue to eat through sizable hoards of cash to complete business plans that may never succeed. In recent months, some bondholders have begun trying to stop them, testing the limits of how early in the trajectory of a distressed company debt holders can pressure firms to change plans. The move by creditors tests a gray area in corporate law: Just when does the fiduciary obligation of a board first shift from strictly shareholders to include creditors?
Telecom companies "are in an environment where there isn't going to be any tomorrow. Bondholders are saying, 'The best I'm ever going to do in terms of recovery is today,' " said Brad Eric Scheler, a partner at law firm Fried, Frank, Harris, Shriver & Jacobson.
Rhythms and Covad Communications Group Inc. of Santa Clara, Calif., another digital-subscriber-line, or DSL, provider, are two companies whose bondholders are pressing management to halt spending. Lawyers and financial advisers say bondholders are privately making similar demands at other telecom companies.
"When management sees a cliff approaching, is it appropriate to keep speeding forward?" asks Daniel J. Arbess, head of the restructuring arm of Triton Partners, a bond investor with $1.4 billion of high-yield investments. Triton is involved in a number of such cases, which Mr. Arbess declines to identify. "If market changes raise questions about whether a company can continue as a going concern, management has an obligation to all stakeholders, including bondholders and other creditors."
It remains to be seen whether the bondholders' initiatives will prove effective or go down as futile attempts to limit losses on failed investments. No one twisted the arms of bondholders to purchase bonds in fledgling companies. Now, these bondholders are complaining that telecom companies are continuing to spend capital to expand their networks -- which is exactly what management had always told creditors they would do with the money.
What makes the telecom cases so unusual, restructuring experts say, is that in most other industries, bondholders wait until there is a default to begin negotiating with management. But in those industries, they explain, bondholders are often more confident there will be sufficient value remaining in a company to give bondholders an acceptable recovery through restructuring.
In telecom companies, on the other hand, troubling questions have emerged about the value of assets of companies that have sought bankruptcy protection. Bondholder advisers point to the liquidation of NorthPoint Communications Group Inc., in which the bulk of the company's assets were sold for $135 million, a fraction of the money raised through the sale of stock and bonds, as evidence of why early intervention is necessary.
But case law doesn't give bondholders a lot of leverage to force the hand of management prior to a default, said Robert Rosenberg, a partner at Latham & Watkins.
At a healthy company, the board owes its fiduciary responsibility to shareholders. When a company files for protection under Chapter 11 of the Bankruptcy Code, its fiduciary duty broadens to include bondholders and other creditors. Case law in Delaware, where many companies are incorporated, also holds that directors owe a fiduciary duty to bondholders when a company is in the "vicinity of insolvency," bankruptcy lawyers say. Exactly what puts a company in that vicinity is subject to debate, lawyers say.
"If they're sitting with a whole bunch of cash and clearly able to pay their debts for a whole year, how do you argue that they're close to insolvent?" Mr. Rosenberg asked.
The situation at weak telecoms is complicated further by a divergence of interests. Management, whose fortunes are often tied to the company's stock, has an incentive to "swing for the fences," as the stock is likely to be worthless in a bankruptcy. Bondholders are often more interested in capital preservation.
In its most recent quarterly report to the Securities and Exchange Commission, Rhythms acknowledged it wasn't generating sufficient revenue to fund operations or to repay debt and preferred-stock obligations. Unless it raises new money, which it is attempting to do, the company said, its funding will last only into January 2002. "These factors raise substantial doubt about the Company's ability to continue as a going concern," Rhythms warned.
A committee of Rhythms bondholders has told the company that it considers Rhythms to be in the "zone of insolvency." The committee has asked the company to wind up operations and distribute the cash to bondholders, a person familiar with the matter said. The company, thus far, hasn't veered from its plan to raise more capital to fund the business. But it has taken steps to reduce spending. It has laid off 850 people in recent months and withdrawn from nearly 600 local-equipment hubs. On June 14, it announced plans to focus on its 33 largest markets, down from 60 when the year begun. A Rhythms spokeswoman declined to comment on discussions with bondholders.
Covad Communications, which also warned it might not survive as a "going concern," posted a cash-burn rate of about $2.6 million a day during the first quarter and reported a net loss of $199 million for the period. It said that without new money, it expected the capital to last only until the second quarter of 2002. Yet it finished the most recent quarter with $637 million in cash and liquid investments.
On April 27, New York lawyer David Rosner, who represents a committee of bondholders, told the company by letter that Covad "cannot, like NorthPoint, simply continue to dissipate the funds necessary to restructure and to repay its creditors."
In recent months, Covad has laid off 1,200 employees, closed 350 local-equipment hubs and decided to liquidate the BlueStar unit, which it said will make available cash last until July 2002. Covad said it is cutting its cash burn to $137 million for the current quarter from $233 million for the first quarter.
Don Sinsabaugh, an analyst with Punk Ziegel & Co. in New York, estimates Covad's cash burn will fall to $125 million or less for the third quarter.
Write to Mitchell Pacelle at mitchell.pacelle@wsj.com and Shawn Young at shawn.young@wsj.com |
