Moody's rates Metromedia Fiber proposed notews
November 1, 1999 11:49 AM
(Press release provided by Moody's Investors Service)
NEW YORK, Nov 1 - Moody's Investors Service assigned a B2 rating to Metromedia Fiber Network, Inc.'s (MFN) proposed $600 million senior notes due 2009 (comprised of a US dollar and a euro portion.)
Moody's also confirmed the B2 rating on the existing $650 million 10% senior notes due 2008 and on the issuer rating. The senior implied rating remains B1.
The outlook has been changed from stable to positive.
The rating reflect the risks related to the company's short operating history, rapid geographic and operational expansion, and our view that the company will likely continue to broaden its strategy.
On the positive, we recognize good management and the relationship with Metromedia Company, a strong strategy that allows for sectors of limited competition, and a fully funded business plan.
We also recognize that the developing relationship with Bell Atlantic provides a significant junior capital investment and a dark fiber contract.
The outlook on the ratings has been changed to positive, due in part to the Bell Atlantic relationship, the strengthening of the capital structure over the near term and MFN's operating success to date.
While we can imagine additional developments between Bell Atlantic and MFN that would be beneficial to the ratings, the probability of occurrence is currently uncertain.
Structurally, the $600 million of senior notes are subordinated to debt at the operating companies and pari passu with the existing bonds.
Due to the increased equity account caused by the stock acquisition of AboveNet for $1.8 billion and the expected investment of $700 million from Bell Atlantic, the indenture allows MFN considerable flexibility in raising additional debt.
Moody's estimates that indenture will permit the company to raise approximately $5 billion after the completion of the proposed notes and $6.5 billion in the first quarter of next year (when the Bell Atlantic investment is expected).
Although the company's current business plan does not require additional funding, Moody's thinks that expansion is likely.
We expect that additional debt would likely be pari passu to the bonds at the holding company, although we note that a relatively modest size secured credit facility is permitted.
MFN was formed in 1993, however operations have accelerated since the Metromedia investment in 1997, which gave Metromedia control of MFN and placed several of Metromedia's experienced managers in key operating positions.
The planned geographic expansion takes the company from 11 domestic and 7 international cities in operation or development today, to 50 domestic and 17 international cities in the next couple of years.
The company's strategy is still rather unique in the local telecommunications market.
It provides long-term leases of its dark fiber cable (no electronics) to communications companies, large corporate customers and government entities.
In its cities, the company generally installs cables with 432 fiber optic strands.
As Qwest Communications and others have shown in the long distance market, the economics of network construction are such that it is far more cost effective for companies to essentially share in the cost of a large fiber installation than to build several smaller capacity fiber networks. MFN therefore can offer companies the ability to enter the market faster, at less cost and with greater bandwidth than they could otherwise.
This is a major attraction for Bell Atlantic, improving its fiber penetration within its traditional markets, as well as its potential expansion into new markets.
Since first rating MFN last year, we have seen the demand for data services surge and demand for local private lines accelerate.
Last month MFN acquired AboveNet. AboveNet improves the efficiency of the Internet, carrying traffic over its private network.
It delivers the traffic as close to its destination as possible before dropping it off to the Internet service provider or server host.
MFN's acquisition of AboveNet makes sense on several dimensions.
First, in Intel-like fashion, MFN's offering of AboveNet services creates demand for its core dark fiber product.
Second, AboveNet will be more valuable on MFN's owned network rather than its current leased lines. Third, together they can serve a broader customer base by offering a more complete solution.
However, the most intriguing possibility may be the ability to provide corporate customers with a lower cost, broadband alternative communications solution.
Since AboveNet is designed to be a highly reliable, low latency Internet protocol network, the company has the ability to provide competitive retail services in the future.
Although we note that this is not part of the company's current plans. While MFN has a lot of potential, it also has a large amount of development to complete.
Over the course of the next couple of years the company plans to greatly accelerate the development of its networks in the US and Western Europe.
Managing the growth of the network as well as the growth of the operations will continue to be critical. We also expect that the MFN will use its new financial strength in the near future to take advantage of additional growth opportunities.
While Moody's respects management's abilities, the scale of the growth will be new to them.
The Bell Atlantic relationship provides significant opportunities for MFN. With $700 million in stock investment and $975 million in subordinated convertible debt (expected funding in the first quarter of 2000), the company's balance sheet picks up considerable strength.
Also, the $500 million dark fiber contract (which funds over three years for fiber which is delivered over five years) makes Bell Atlantic a major customer. We expect this contract is likely to grow over time.
Certainly Bell Atlantic could have signed a dark fiber contract without making an equity investment, so it's reasonable to expect that an expanded relationship is contemplated in the future.
However, what form this takes or whether it is even completed is too speculative at this point to provide much ratings impact. Financially, MFN has good cash generation. It receives a significant amount of cash up-front on the dark fiber contracts, which are initially recorded as deferred revenue.
Because of this, EBITDA is not an accurate measure of the company's cash flow. We estimate that debt will reach five times cash-from-operations (excluding any benefit of deferred revenues) in four years. (It is worth noting that various regulatory and accounting organizations are reviewing the accounting treatment of dark fiber contracts.
At Moody's we analyze the cash effects of these contracts, so the outcome of this review is not meaningful to us.) Metromedia Fiber Network has its headquarters in White Plains, New York.
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