A Bankruptcy Boom Is Starting To Have Ripple Effects
By JEFF ST.ONGE
Of DOW JONES NEWSWIRES
WASHINGTON -- Several recent earnings announcements show that this year's flood of Chapter 11 filings, debt defaults, business failures and liquidations are affecting the bottom lines of otherwise healthy companies.
Coupled with tighter credit, this trend may cause a kind of spiral, forcing more companies to default and file for bankruptcy - and leading still more companies in a variety of industries into financial distress, or at least lower profits.
Credit ratings agencies Moody's and Standard & Poors recently said that defaults in the first half of 2000 soared to levels not seen since the recessionary years of the early 1990s.
In July, S&P said that at the current pace the default rate would stand at 2.4% - a rate only exceeded by those of 1990 and 1991. S&P added that a sharp rise in interest rates or an economic downturn would probably push default ratios to levels not seen in a decade. Moody's said the default rate in the second quarter was the second highest since 1991 and that nearly half of these defaults were Chapter 11 filings. The ratings agency predicted that the default rate will climb to 8.4% by June 2001, from 4.9% in July. In line with predictions, Moody's reported the default rose to 5.1% in August.
In September, the Office of the Comptroller of the Currency reported that troubled loans to U.S. business have more than doubled in two years, to $100 billion, despite the relatively good economy, fueling concern that lenders are using overly lax credit standards to gain market share.
Largely due to the recent rise in defaults and bankruptcies, analysts say a growing credit crunch is under way in the U.S. While an insatiable need for capital is going largely unmet in the high-technology sector, all types of companies - from movie theater chains to furniture retailers to transportation and agribusiness concerns - are having trouble raising cash to stay afloat.
The recent surge in bankruptcies and defaults can't be blamed on industry-specific factors as it had been in the past. The fact is, bankruptcies in 2000 touch every sector of the economy.
In the latest high-profile case, Owens Corning (OWC) and 17 affiliates Thursday morning filed for Chapter 11 in Delaware, citing the need to address cash-flow demands resulting from multibillion asbestos liability.
Given today's higher fuel prices, it's no shock to see shipping, trucking, air cargo and other transportation companies feeling the pinch and filing for bankruptcy.
But at the same time, one finds a high number of energy-sector businesses seeking court protection from creditors as well.
In the health-care arena, real estate investment trusts, hospitals, laboratories and pharmaceutical companies are suffering as a result of a slew of bankrupt nursing home chains. Four of the nation's largest nursing home companies, and several smaller ones, are operating under Chapter 11.
In agribusiness, Crown Cork & Seal Co. (CCK) is owed about $75 million by bankrupt farming cooperative Tri-Valley Growers (X.TVY).
Crown, in revising its earnings forecast downward on Sept. 28, said "2000 is proving to be one of the most difficult years experienced by the company in recent history" because its business is volume-sensitive, and food-can volumes are expected to be softer because of Tri-Valley's problems.
Creditors and Customers Affected
In certain areas such as retail, bankruptcies are just a fact of life, regardless of the economic climate. Chapter 11 allows retailers to reject unfavorable leases and close underperforming stores. Yet with any other sector, when a retailer files for bankruptcy its landlords, other creditors and shareholders often stand to take a bath, particularly if it can't reorganize and liquidates.
In July, for instance, carpet supplier Shaw Industries Inc. (SHX) recorded a $26.5 million second-quarter nonrecurring charge to reflect the impact of home decor retailer Flooring America Inc.'s (FRAE) bankruptcy.
And it's not just a debtor's suppliers that might take a hit, a bankrupt company's customers can be hurt by its filing too. Last month, Tricon Global Restaurants Inc. (YUM) said that its financial exposure to what was once its only supplier, the now-bankrupt AmeriServe Food Distribution Inc. (AMSV), was in the neighborhood of $100 million.
In particular, the volatile, ever-changing high-technology sector shows the potential for ripple effects from debt defaults and bankruptcy filings.
Until recently, upstart telecommunications firms and other high-tech companies took advantage of easy credit and overzealous lenders to try to grow revenue. But as the capital markets have become less willing to lend, there's been a rising tide of overleveraged, non-cash-producing companies in this sector that are unable to address their business needs.
But it's not just traditional capital markets that are drying up. Vendor financing is increasingly hard to come by as equipment makers continue to get burned by upstart debtors, a trend showing up in lists of top creditors in bankruptcy filings.
Upstart local telephone company GST Telecommunications Inc.'s (GSTXQ) is by no means the only telecom or high-tech company to leave its equipment suppliers lined up to collect debts behind other creditors. But GST's bankruptcy and difficulties at ICG Communications (ICGX), another competitive local exchange carrier, or CLEC, which owes creditors more than $2 billion, have increased concerns about cash-burning telecom and Internet infrastructure providers suddenly becoming unable to pay their debts.
An affiliate of Nortel Networks (NT) acted as the secured vendor of switching equipment in eight of GST's local networks, and claims in court documents that GST owes it about $45 million. NextLink Communications (XOXO), another CLEC, said GST owes it around $4 million.
In August, privately held American MetroComm Corp. and its affiliates filed for bankruptcy protection leaving a $53 million lawsuit with Cisco Systems Inc. (CSCO) up in the air. Cisco had sued the New Orleans-based CLEC for refusing to pay for phone and data switching equipment ordered last year through a Cisco reseller. A unit of Lucent Technologies (LU) is American MetroComm's second largest unsecured creditor, with a $26 million claim related to trade debt and an unsecured loan. Network equipment maker Ciena Corp. (CIEN) recently said it planned to write off up to $28.2 million in accounts receivable from a customer that filed for bankruptcy.
In just the past few months, dozens of other Internet and telecom start-ups have filed for bankruptcy. While such failures will only dent the bottom line of the larger telecom and telecom equipment companies, the smaller ones might experience considerable shortfalls.
On Tuesday, DSET Corp. (DSET) slashed bottom-line forecasts for this year's third and fourth quarters, and trimmed projected 2001 revenue because of spending cutbacks by telecom firms. NETtel Communications Inc., which filed for bankruptcy last Friday, owes DSET about $2 million.
The telecom sector's Internet progeny is probably even more rife with failures and potential losses, and it's not just equipment suppliers that are getting hit for losses.
Starbucks Corp. (SBUX) wrote down its equity investment in Living.com after the online furniture retailer filed for a Chapter 7 liquidation in August. The ubiquitous coffee vendor took a $20.6 million pretax charge related to its investment in the fourth quarter ended Oct. 1.
Coincidentally, one of Starbucks' major cup suppliers, Thermo-Serv Inc., also filed for Chapter 11 protection this year, in January.
In another high-tech case, the largest unsecured creditors of bankrupt computer distributor MicroAge Inc. (MICAQ) are Hewlett-Packard Co. (HWP), owed $55.7 million; Panasonic Personal Computer Corp., $18.5 million; Cabletron Systems Corp. (CS), $13.4 million; Lucent, $12.8 million; and Microsoft Corp. (MSFT), $10.5 million.
Outside circles of bankruptcy professionals and vulture investors, few people realize that 1999 brought more assets and more debts into bankruptcy court than ever before. That's probably because this trend didn't seem to have much impact on the overall health of the U.S. economy.
Today, most people are likely to be aware that the U.S. economy is experiencing a slowdown, especially with more and more high-profile companies seeking bankruptcy protection. Meanwhile a spate of earnings warnings have investors on edge.
With the aftershocks of the past year's bankruptcy boom and a slew of new Chapter 11 filings eroding revenue and cutting into corporate profits, corporate bankruptcy may replace the Internet's future as the hottest financial topic.
-Jeff St.Onge, |
