Silicon Valley: Motorola's Ball and Chain
By Carole Winkler
Special to TheStreet.com
In its second-quarter earnings release Tuesday, Motorola (MOT:NYSE)
said it will soon have a better idea of how much it will ultimately
have to shell out to cover Iridium's (IRID:Nasdaq) financial failings.
But some analysts already are betting the number could be huge.
Alex Cena, an analyst with Salomon Smith Barney, says Motorola could
lose $1 billion to $1.7 billion thanks to Iridium's continuing
financial woes. (Solly hasn't performed underwriting for Motorola or
Iridium.) After allowing for $800 million in reserves already, the
financial hit would be $200 million to $900 million, depending on when
Motorola had to recognize the losses. At a maximum, a loss of this
magnitude could equal Motorola's earnings for a whole year.
But Motorola, which owns 18% of Iridium, said in its earnings release
that "the previously announced sales of several businesses and assets
are expected to generate significant gains and significant cash inflows
in the third quarter, enabling Motorola to maintain a strong financial
position, even with the negative impact of charges that may need to be
absorbed by Motorola in the financial restructuring of Iridium LLC."
Still, the company said an Iridium restructuring could "necessitate an
additional special charge" in the third quarter. It also noted that, in
the second quarter, Motorola again deferred recognition of profits from
its big operations and maintenance contract with Iridium. And it
recorded a $126 million charge to write down the value of Iridium
bonds.
Excluding charges, Motorola earned $273 million, or 44 cents a share,
in the quarter, beating the First Call consensus of 41 cents a share
and far better than the year-earlier's $6 million, or 1 cent a share.
Iridium's debt load is staggering -- totaling $3.5 billion -- which is
forcing talk of a massive restructuring. It has $1.5 billion in
high-yield debt outstanding; an interest payment is due on that debt
July 15, with a 30-day grace period. It already is in danger of
defaulting on financial covenants relating to an $800 million secured
credit facility that is deferred until Aug.11. If Iridium defaults on
that, then the company will also be considered in default of another
$750 million credit line guaranteed by Motorola, not all of which has
been utilized by Iridium. In addition, by Sept. 1 Iridium will owe
approximately $470 million to Motorola: $400 on an
operations-and-maintenance contract and $70 million previously owed to
Motorola from Iridium.
Meanwhile, Iridium sits with slack demand for its satellite phones.
Iridium was supposed to sign up 27,000 customers by May 31; it had only
10,294. It slashed prices July 1 by up to 68%, and its current
subscriber base is estimated at 15,000 to 20,000. Iridium says it'll
report new subscriber figures at month's end. One problem: Low-earth
orbit satellite phones don't work well in buildings, a fact stated in
the owners' manuals but which many impatient customers never read.
"Iridium, like others in the satellite industry, underestimated the
time, energy and expense that have to be put toward the marketing,
sales and distribution," says Ed Cornet, vice president of commercial
space at Booz-Allen & Hamilton, which has done consulting for Iridium.
"There is a belief in the industry that if you can do the rocket
science of getting the satellites launched and working that you can do
anything. Unfortunately, nobody makes any money until the systems are
sold and used heavily."
Analyst John Bensche of Lehman Brothers believes Iridium will survive
because it's in all parties' best interests for the satellite network
to generate revenue. (Lehman hasn't performed underwriting for Iridium
but has underwritten for competitor Globalstar Telecommunications
(GSDRF:Nasdaq).)
"In a sense, the creditors have a gun to their own heads," says
Bensche. That's because a majority of the shareholders -- including
Motorola -- are strategic partners of Iridium that own the licensing
and gateways in other countries, says Bensche. "If the creditors
alienate the gateways by trying to grab too much of the pie, they will
be stuck with 66 satellites with no salvage value," he says.
Motorola also has profited from its relationship with Iridium. It
already received $3.5 billion as prime contractor to build Iridium,
which was finished in November 1998. Of course, Motorola hasn't
recognized the profits from that contract, instead placing around $800
million into financial reserves, including $50 million in the first
quarter, according to Cena at Solly. Motorola didn't specify whether it
put aside more reserves for Iridium in the second quarter. If Iridium
survives, Motorola could complete the five-year operations and
maintenance contract, bringing combined total revenue from Iridium to
around $6.7 billion.
One analyst thinks that Motorola's profitable contracts with Iridium
may be partially responsible for Iridium's financial woes.
"Motorola is playing both sides of the equation here," says analyst
William Kidd of C.E. Unterberg Towbin, a firm that hasn't underwritten
for Motorola or Iridium. "The operations and maintenance contract is
very profitable for Motorola and expensive for Iridium. They are
charging $500 million per year for services that cost them between $150
and $200 million to provide." Motorola declined to comment on the
issue.
The trick will be to convince bondholders to accept more equity in lieu
of payment and convince the shareholders to accept a large dilution,
says Kidd. "Afterwards, if Iridium goes bankrupt, dilution will occur
to an even greater extent because Motorola will acquire a pseudo-equity
position proportional to the debt. The resulting dilution will be
huge."
Neil |
