Agere IPO Isn't All That It Seems: Christopher Byron
Weston, Connecticut, Feb. 14 (Bloomberg) -- In the dark of night, when fog and foreboding envelop the moors, one can hear the faint creaking of a coffin lid. It is the ghost of bull markets past, emerging anew to stalk the land. From Wall Street's tales of the crypt comes this week's blood-curdling yarn. The beast from the undead that neither garlic nor daylight could banish for long: The IPO lives!
This week we look at Agere Systems Inc., the telecom chip outfit that is being pulled from the loins of Lucent Technologies Inc. by Morgan Stanley Dean Witter & Co. for as much as $7.4 billion in gross proceeds.
There's been a fair amount of excitement about this deal lately -- mostly flowing from the usual sell-side cheerleaders for such things. In the main, the rah-rah boils down to assertions that the sheer size of the offering is what really matters, meaning that if the market can somehow choke down $7 billion of new stock hitting the Street all at once, investors will have cause to rejoice.
We view things differently. We see this deal as being not terribly different from the sort of bad-bet stock offerings Wall Street investment banks have been bringing to market since the memory of man runneth not to the contrary.
In this case the deal boils down to a plan created by Morgan Stanley to help Lucent shareholders escape further misery from a stock that has plunged 83 percent in the past 14 months.
Debt Strategy
This isn't an initial public offering designed to create value for Agere's investors at all. No, this is an attempt to pull Lucent's entire long-term debt load, which is rapidly sinking toward junk status, back out of the market and stick it, in the form of diluted equity, on the shoulders of a whole new set of chumps: the future shareholders of Agere.
We'll explain how this three-card-Monte ploy is intended to work in a minute. But first some thoughts on how Lucent got to this sorry state in the first place, and what now lies ahead for everyone in this deal.
Lucent, from which Agere is emerging via the Wall Street version of a C-section, is itself the Caesarian result of some earlier handiwork by Morgan Stanley, which ripped it from the loins of AT&T Corp. as an IPO back in the spring of 1996.
Since Lucent was, in effect, the crown jewel of AT&T, supplying the telecommunications company with the majority of its manufacturing and research capability, it isn't surprising that Lucent thereafter soared 981 percent in the runaway bull market in tech stocks that ended last spring, whereas AT&T didn't even double.
Loans to Customers
But a huge share of Lucent's business came from selling switches and other telecom gear to small, under-capitalized startup companies in the so-called service-provider arena -- and actually lending them the money to buy the equipment. It is an arrangement that has now placed the company on the hook, as of Sept. 30, for $1.4 billion of guarantees on customer borrowings and $1.3 billion of loans by the company to the customers themselves.
It is almost impossible to ferret out from Lucent's financial reports just how much trouble this has gotten the company into. But in a conference call with Wall Street analysts on Jan. 26, Chief Financial Officer Deborah Hopkins gave a pretty clear hint.
Hopkins said sales to large customers were actually up 7 percent in the fourth quarter, whereas total revenue collapsed by 40 percent. The obvious conclusion: The backbone of Lucent's business is small companies that aren't able to buy equipment in the current economic slowdown.
SEC Investigation
And that's not Lucent's only problem these days. On Feb. 9, Lucent announced that the Securities and Exchange Commission was investigating the circumstances surrounding the company's decision to book -- and then later to exclude -- some $679 million in 2000 sales. SEC inquiries into such matters often lead to the development of fraud cases by the enforcement division, but no allegations of wrongdoing have been made so far in the present matter.
Lucent is now in the process of firing 10,000 workers, with 6,000 more scheduled for the heave-ho down the road. The company is also planning to close a bunch of manufacturing plants as well as write off $1.2 billion in assets. Meanwhile, Morgan Stanley has stepped up to the plate with an IPO scheme to dress up the financials even more by spinning off Lucent's prized optical components and semiconductor division. Agere provided 11 percent of Lucent's 2000 revenue and all its operating cash flow.
Anticipated Price Range
If this deal were being put together as a straight-ahead offering, it might be worth buying. Agere, as presented in the registration statement, shows revenue of $4.7 billion and a 45 percent gross profit margin of $2.1 billion. The business shows a net loss for the year ended Sept. 30, but that's only because of $446 million in acquisition write-offs. Take them out of the picture and Agere would have reported $370 million of net income, or a respectable 8 percent profit margin.
What's more, an amended registration statement filed last Wednesday with the SEC suggests an offering price in the range of $15 to $20 a share, which would make Agere, coming out of the gate, one of the most capitalized companies in America.
But that is not what is happening. What is happening, instead, is that roughly 40 percent of the proceeds will never reach Agere at all, but will be spent, instead, by Morgan Stanley to pay down debt on the Lucent balance sheet -- and in a way that seems designed to make it as hard as possible for Agere investors to see what is really happening.
The Would-Be Numbers
If this offering were set up so investors could see what was actually going on, no one would invest in the IPO at all. The pro- forma balance sheet would show cash from the stock sale of $3.75 billion (assuming an offering price of $17.50 a share) and various other assets of $7.2 billion, for a total of just under $11 billion. But against that would be set not only liabilities of $3.9 billion for things like pension obligations, accounts payable and whatnot, but also $2.5 billion or so of long-term debt that had been moved over from Lucent's own balance sheet.
This would net out to balance-sheet book value of no more than about $4.6 billion instead of the $7.1 billion that shows on the pro-forma balance sheet being presented by Morgan Stanley in the IPO registration statement. What's more, Agere would begin life as a leveraged operation, with long-term debt approaching the total book value on the balance sheet. Nor would that book value be worth very much either, when you consider that most of it would be represented by goodwill and intangibles.
Morgan Stanley's Plan
And there's more. Not only would some $750 million of that debt be coming due July 15, but the company would be burdened thereafter with roughly $350 million in annual interest payments for many, many years. These payments would put the company into the red on an income basis for years, and cut its cash flow in half. Who would want to invest in something like that?
So here's how the boys at Morgan Stanley have gotten around the problem. Instead of having Agere issue just 222.6 million shares and keep the proceeds while picking up Lucent's debt directly, Morgan Stanley will itself acquire, in effect for free, 147.65 million additional shares of Agere stock, then sell them in the IPO and use the proceeds to buy Lucent's outstanding debt in the public market.
For Lucent, the net effect is the same: It sheds its debt -- which was the real point of the IPO from the start. For Morgan Stanley, there's the bonanza of additional fees for all the folderol involved. And for people dumb enough to invest in Agere itself? Well, it is they who will pay the price, as 40 percent of the per-share book value of their investment will be wiped out by the manner in which the IPO will convert Lucent's debt into Agere's equity without providing any benefit whatsoever to Agere itself.
Aren't gains like that great? Don't you just love it when white-shoe deal machines like Morgan Stanley collect nine-digit fees for dreaming them up? Morgan Stanley: the firm that brought you Women.com Networks Inc., Ask Jeeves Inc., WebMD Corp., and a dozen more IPO calamities just like them. To its ghoulish parade of IPO horribles we now may add yet another fiasco in the making: Agere Systems. And if I'm wrong about that one, well, as we say in New York, I'll kiss your ass in Macy's window.
Feb/14/2001 9:16 ET
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