Motorola's Multiple Roles Contributed to Collapse of Iridium Satellite Technology News (Part I)
Tue, 19 Oct 1999, 4:45pm EDT
By Ida Picker
Motorola's Multiple Roles Contributed to Iridium's Collapse
New York, Oct. 19 (Bloomberg) -- ``Hello' says the cover of
Iridium World Communications Ltd.'s second -- and probably last
-- annual report. The satellite telecommunications company, which
debuted on the stock market just 28 months ago, may soon be
saying ``Good-bye.'
While Iridium's constellation of 66 satellites hovers in the
sky, the company itself has come clunking down to Earth. Iridium,
backed by 19 telecommunications and electronics companies, filed
for Chapter 11 bankruptcy protection in August. It's now trying
to restart itself as a smaller business and appease its
creditors. With just $200 million in cash and virtually no
income, Iridium faces $1 million a day in expenses and owes $1.55
billion to banks and $1.45 billion to bondholders.
Iridium owes the most, $2.9 billion, to Motorola Inc. -- the
Schaumburg, Illinois, electronics company that invented,
designed, financed, built, supplied, operated and maintained much
of Iridium's system of satellites, ground stations and
telephones.
There are many reasons why Iridium went bust. The company
had bulky telephones that weighed as much as one pound, cost as
much as $3,000 and didn't work well in buildings or cars. What
really doomed Iridium, however, may have been the multiple, and
often conflicting, roles played by Motorola. Some investors say
that as the prime contractor on the project, Motorola milked
Iridium and used the partners' money to finance its own foray
into satellite communications technology.
Shareholder Suit
``Motorola used Iridium as a vehicle to amass a presence in
the global satellite industry,' alleges a shareholder suit filed
in June against Iridium and Motorola by Berger & Montague PC, a
Philadelphia law firm. ``By using Iridium, Motorola ensured that
its reputation would not be tarnished if the project failed, and
also ensured that it would not be required to completely bankroll
the satellite project.'
Motorola, which owns 18 percent of Iridium's stock, hasn't
escaped from this fiasco unscarred. The world's No. 2 maker of
cellular phones has written down the value of its Iridium shares
to zero. It expects to lose $2 billion on Iridium -- serious
money at a company that had revenue of $29.4 billion and a net
loss of $962 million last year. On Oct. 12, Motorola took a $994
million pretax charge for its Iridium losses.
But these numbers don't tell the full story.
So far, Motorola has collected $3.65 billion on its $6.6
billion in Iridium contracts. SG Cowen analyst Wojtek Uzdelewicz
estimates that Motorola, after covering expenses and paying its
suppliers, has pulled in $750 million in profit from the
contracts -- bringing down the company's net loss on Iridium to
$1.25 billion.
Motorola also will emerge from the wreckage of this project
with new expertise -- and more than 1,000 patents -- in building
satellite communications systems.
Follow-on Work
In July, Teledesic LLC signed up Motorola as prime
contractor to build its 288-satellite ``Internet in the Sky' to
compete with terrestrial fiber optic networks. Backers of the
Teledesic project, which will cost as much as $15 billion and
transmit data, video and voice, include Boeing Co., Microsoft
Corp. CEO Bill Gates and cellular magnate Craig McCaw.
``Motorola's experience from Iridium positioned it very well
for follow-on work that could be worth billions of dollars in
Teledesic contracts,' said Edward Snyder, a Hambrecht & Quist
telecommunications analyst.
Motorola investors don't seem too troubled by the company's
Iridium losses. Its stock rose 79 percent to 88 1/8 in the 12
months ending October 18.
Iridium's shareholders, bondholders and bankers have been
less fortunate. Iridium stock plunged 92 percent from a high of
70 in April 1998 to 3 1/16 when trading was halted last Aug. 13.
The price of Iridium's 14 percent, eight-year notes dropped 87
percent from March through October 18.
Complaints Denied
Iridium's banks are trying to collect on $800 million in
loan payments due by December 2000. The loans were secured by
Iridium's still floating, but barely utilized, satellites.
At least 20 groups of investors have sued Iridium and
Motorola, charging that the companies, their executives and their
underwriters knowingly issued false and misleading statements
about Iridium's financial condition and marketing prospects.
Motorola denied those allegations. ``The claims we've seen
against Motorola are groundless,' said Motorola spokesman Scott
Wyman. ``We plan to defend them vigorously and we expect to
prevail.'
Wyman called the view that Motorola's multiple roles in
Iridium had contributed to its collapse ``absolutely not
correct.' He blamed Iridium's problems on ``a flawed go-to-
market plan' and ``a too-high and complex price structure.'
Motorola played a key role in developing Iridium's marketing
plan and pricing structure. Motorola Chief Executive Christopher
Galvin and other senior executives declined to be interviewed for
this story. Spokesman Wyman sent replies by fax machine to
written questions.
Executive Bloodbath
Iridium now has about 20,000 customers worldwide. Since
April, almost all of its top executives have quit or been fired,
including Chief Executive Edward Staiano, a 23-year veteran of
Motorola.
Joseph Bondi, the Alvarez & Marsal Inc. turnaround expert
whom Iridium hired in September, is seeking support for a smaller
company with lower costs. Assuming that partners and creditors
buy into the plan, lawyers probably will try to get bondholders
and lenders to convert most of their debt to equity. Iridium
partners may invest an additional $500 million in the foundering
project.
First, though, Bondi will have to overcome the distrust that
other Iridium investors have of Motorola. From Iridium's
inception, Motorola has worn more hats than a carnival barker.
Iridium was born in 1985, after Karen Bertiger, a real
estate broker vacationing in the Bahamas, complained to her
husband, Bary, that she couldn't get her cellular phone to
connect to a client back in the U.S.
Demand Forecast
After the trip, Bary Bertiger, a Motorola engineer,
brainstormed with his colleagues and came up with the notion of a
constellation of low-Earth-orbit communications satellites that
would enable anyone to call anyone from anywhere. They named the
project Iridium after the element with 77 electrons, the number
of satellites they originally envisioned.
Some big telecommunications companies spurned early appeals
for investment from Motorola, then led by Chairman Robert Galvin,
father of the current CEO.
``We'd seen a lot of research that called into question the
actual demand for satellite service,' recalled Kenneth Wu, a
spokesman for AT&T Corp.
Herschel Shosteck, head of his own wireless
telecommunications consulting firm in Wheaton, Maryland, was
author of one research report that AT&T executives read. In
January 1993, he said Iridium was likely to flop because its
technology was unproven. ``We place the chance of its economic
success at one in 10 or less,' he wrote.
Shosteck says Motorola predicted in 1990 that it would have
6.76 million subscribers by 2001.
Forecasts Questioned
``It was clear the demand forecast was developed by Motorola
engineers to show a `good market' for the end of building the
satellites,' Shosteck says. ``It had nothing to do with a
rational business analysis.'
Motorola, calling its forecast ``proprietary information,'
declined to confirm the 6.76 million subscriber number.
By 1994, Motorola had rounded up a hodgepodge of 18
``strategic partners,' including Sprint Corp., the third-largest
long-distance phone company in the U.S., and two large U.S.
defense companies, Raytheon Co. and Lockheed Martin Corp. Other
strategic partners consisted of a consortium of companies from
places like China, the Middle East, Africa, India and Russia.
In exchange for a total investment of $3.7 billion, the
partners got equity and board seats. They agreed to buy
additional Iridium equity and debt, if necessary, and to become
gateway investors, financing and operating Iridium's ground
stations, known as gateways.
Motorola ponied up $400 million, giving it 25 percent of the
equity, the largest stake by far. The company held six seats, the
biggest bloc, on Iridium's board.
Tom Sawyer's Fence
While spreading the risk, Motorola retained the most power.
Like Tom Sawyer, who talked his friends into paying him for the
privilege of painting his backyard fence, Motorola persuaded its
partners to finance its development of space-age communications
technology.
Iridium itself was a sort of toothless tiger from the
outset. It didn't have the authority to sell or service any
phones anywhere. The partners controlled marketing, pricing and
distribution. Iridium set the wholesale rates of its phone
service and signed major contracts with Motorola, which then
farmed out some of the work to subcontractors.
This setup was rife with conflicts of interest. Many
partners were also suppliers to Iridium or subcontractors to
Motorola. Two of the partners -- Motorola and Japanese
electronics giant Kyocera Corp. -- made all of the Iridium phones
and pagers.
Motorola and Kyocera set identical retail prices for their
phones: $3,000. In the prospectus for its initial public
offering, Iridium expressed concern -- presciently -- that this
price might damage the product's market appeal.
Conflicts of Interest
Motorola drew cash from Iridium's till in many ways. The
$6.6 billion in contracts that Iridium awarded Motorola included
$3.45 billion, payable from 1996 to 1999, for designing and
launching satellites.
The prospectus for Iridium's IPO says that the negotiations
for all of these contracts, which took place while Iridium was
still a subsidiary of Motorola, ``were not conducted on an arm's-
length basis.'
Analysts say Motorola used its position at Iridium to
negotiate favorable terms for a five-year, $2.9 billion
operations and maintenance contract.
``Iridium grossly overpaid Motorola on the operations and
maintenance contract,' said William Kidd, a satellite
communications analyst at C.E. Unterberg, Towbin. SG Cowen
analyst Uzdelewicz estimated that Motorola built in a 30 percent
profit margin on the O&M contract.
Wyman, the Motorola spokesman, said investors were aware of
the relationship between Iridium and Motorola: ``The partners and
investors had full knowledge and full visibility of the contracts
between Motorola and Iridium before investing and assuming
risk.' Wyman also noted that Motorola has yet to collect any
payments from the O&M contract.
Guarantees
In 1994, Motorola landed a $356 million contract for
supplying hardware and software to Iridium's 12 ground stations.
Motorola even wrote Iridium's payroll checks. For this and other
administrative services, the company rang up $3.8 million in
1994, $604,000 in 1995 and $563,000 in 1996.
Motorola also collected fees for guaranteeing some of
Iridium's debt, a necessary step after Iridium's hapless effort
to tap the bond market.
In 1995, Goldman, Sachs & Co. tried to sell $300 million of
Iridium junk bonds. But wary investors demanded 26 percent
interest rates plus equity.
``It was more like a project than a company,' recalled
Moody's Investors Service analyst Douglas Bontemps, who rated the
subordinated bonds ``Caa,' its second-lowest ranking at that
time. ``They had the blueprints and not much else.' The
satellites weren't up, the ground stations weren't built. Goldman
withdrew the bond issue.
Queasy Investors
Motorola pressed its strategic partners to honor their
promises to put up more money. In 1996, Iridium sold its
partners, including Motorola, a private placement of $238.4
million in 14 l/2 percent senior subordinated discount notes --
more than eight percentage points above what 10-year U.S.
Treasury notes were yielding then.
Bond buyers weren't the only ones queasy about Iridium. So
were the banks. In August 1996, Motorola had to step in to
guarantee a $750 million syndicated loan to Iridium co-led by
Chase Manhattan Bank and Barclays Bank PLC. Iridium benefited
from Motorola's credit rating, paying interest rates ranging from
5.63 percent to 8.5 percent.
But Motorola's guarantee carried a price. As payment,
Iridium granted Motorola 104,000 warrants for stock, which
Iridium valued at $90 million on its books.
In June 1997, just a month after Iridium finally had
overcome a series of technical problems and had launched its
first five satellites, the company did an IPO.
Street of Believers
By now, Wall Street was full of believers. Five out of the
six equity analysts covering the fledgling company rated it a
buy; the other one rated it a hold.
``The target market was virtually the entire world,' said
Kidd of Unterberg, Tobin. He noted that cellular phones, the ones
that relied on towers rather than satellites to relay their
signals, worked on only 15 percent of the Earth's surface.
The IPO, underwritten by Merrill Lynch & Co. for a fee of
about $7.5 million, was a success -- 12 million shares priced at
$20 each, which rose to 54 four months later.
Iridium used most of the $225 million from the IPO to make
payments to Motorola for designing most of the satellite and
ground-station software and hardware.
In July 1997, Iridium sold $1.45 billion in bonds with
interest rates ranging from 10 7/8% to 14%. Iridium used the
proceeds mainly to pay Motorola for the satellites. In December
of that year, Ed Staiano, Iridium's first CEO, tapped the banks
again, for a $1 billion syndicated loan co-led by Chase and
Barclays and secured by essentially all of Iridium's assets,
including ground stations and satellites in production.
Service Begins
Iridium's stock soared to 68 7/8 in May 1998, but by later
that year things were looking dicey. Iridium began service on
Nov. 1, 1998, with just 3,000 customers, a fraction of the
500,000 subscribers that analysts thought the company needed to
break even.
Iridium couldn't come up with the $400 million due on the
O&M contract in November 1998. Motorola agreed to defer payment
until December 2000.
Nobody was happy. Iridium blamed the gateway partners,
including Motorola, for not marketing the service zealously
enough. ``The gateways were very often huge telecoms,' said
Stephane Chard, chief analyst at Euroconsult, a Paris-based
research firm. ``To them, Iridium was a tiny thing.'
The gateways said Iridium's suppliers were late delivering
its phones and pagers. J.P. Morgan analyst Marc Crossman says he
ordered his Iridium phone from Motorola in September 1998 and
didn't receive it until mid-January. Then, he says, he couldn't
use the phone for three weeks because of a delay in setting up
his account.
Customers complained that the phones didn't work inside
buildings. Whatever market there was for Iridium phones shrank
even further with the continuing Asian financial crisis, which
had begun during the summer of 1997.
Running Through $800 Million
Motorola had problems of its own. Declines in its
semiconductor business and a slow entry into digital mobile
phones contributed to its $962 million loss in 1998.
When Iridium's two-year, $1 billion loan came due in
December, the banks refused to renew it. They offered a new $800
million loan, with strings: Iridium had to enroll at least 50,000
subscribers and pull in at least $30 million in revenue by March
31, 1999. Motorola didn't guarantee the new loan. Instead,
Iridium secured it with its assets -- 66 satellites and 12 ground
stations.
Roy Grant, Iridium's chief financial officer, was running
through the $800 million just to pay operating expenses. He
needed more. So in December, Motorola once again stepped up as a
guarantor, this time for a $750 million loan -- on the condition
that the proceeds be used exclusively to make payments to
Motorola.
There were more catches: Iridium had to pay Motorola 12
percent interest on the $400 million due on its O&M contract.
Iridium also promised Motorola warrants to purchase 12.9 million
shares -- and an even bigger say in decision-making. If Iridium
defaulted on its debt, Motorola would be able to elect a majority
of Iridium's board.
Exquisite Timing
In January, Grant did a secondary offering of 7.5 million
shares for Iridium at $33.50 each, led by Merrill and Goldman
Sachs. Despite Iridium's problems, analysts remained starry-eyed.
``I think we on Wall Street were probably a little too
optimistic,' said Kidd of Unterberg, Towbin.
The investors suing Iridium and Motorola contend that the
company didn't fully disclose Iridium's financial problems at the
time of the secondary sale. Iridium completed the sale just
before it released its income statement showing a loss of $1.25
billion for 1998. In February, Iridium said it wouldn't have the
subscribers and revenue it needed to satisfy its loan covenants.
In March, Grant resigned ``for personal reasons.' One bond
analyst said the banks had insisted upon his departure. By late
March, Iridium had signed up only 10,000 customers. In mid-April,
CEO Staiano stormed out of a board meeting and quit. One source
said Staiano left in protest over Motorola's refusal to cut the
price on its O&M contract.
Extensions
The board appointed John Richardson, a former Barclays
executive, as interim CEO. In May, it hired Donaldson, Lufkin &
Jenrette managing director Tom Benninger to advise it on
restructuring.
By now, Iridium's bonds had lost 80 percent of their value.
Bondholders granted Iridium a 30-day extension on $90 million in
payments due July 15. The banks pushed back their covenant
requirements until Aug. 11.
As Iridium floundered, Motorola squabbled with its partners,
chiefly over the money the consortium owed Motorola on the
operations contract. ``The big issue was getting terms on the
payments,' said Leo Mondale, a former Motorola executive who
became Iridium's chief financial officer in May.
Motorola, wearing its contractor hat, wouldn't budge on the
terms. On Sept. 1, Mondale suddenly resigned, the second CFO to
quit in five months. The next day, Iridium named an interim CFO,
David Gibson from Alvarez & Marsal, the turnaround firm. In
November, Motorola agreed to defer payments on the operations
contract in exchange for more warrants. Kidd calls the O&M
contract ``Iridium's biggest weakness.'
Dwindling Equity
Today, Motorola holds 27.3 million shares, or 18 percent, of
Iridium LLC, the parent of the public company. Those shares were
worth $83.6 million when Iridium stopped trading in August.
Motorola also own warrants -- which are now virtually worthless
-- to purchase 7.8 million shares.
As part of the restructuring of Iridium, all shareholders
-- including Motorola -- will almost certainly lose the entire
value of their equity stakes. Motorola may have to give Iridium
$400 million more in cash or contract concessions. That could
push up its losses from $1.25 billion to $1.7 billion.
Bondi, the restructuring chief, is trying to recast Iridium
as a much smaller company, catering to niche telecommunications
markets like oil exploration and shipping.
The partners may embrace this strategy. ``Some gateways are
prepared to invest very substantial sums of money in new
investments,' said D.J. Baker, a Gibson, Dunn & Crutcher
attorney who represents most of the Iridium partners. |
