Allegiance Deals With Debt Dilemma
By Cody Willard
02/12/2003 16:59
Allegiance ALGX is in trouble. Executives at this Dallas-based telecom-service provider have been contending with bank covenant issues, but they've maintained that these problems will somehow be resolved in a way that will be "fair" to all involved parties. However, with no apparent solution in sight, it's getting increasingly harder to see any upside to the shares.
Slip-Slidin' Away
Allegiance takes a tumble
The stock fell to a new 52-week low of 34 cents on Tuesday. Unfortunately, as the stock price dips, shareholders can expect an even smaller piece of the recapitalized pie because the dilution of shareholders is inversely proportional to the stock price. (More on this below.)
Boom and Bust
Here's a little history of the problem. Allegiance began running into bank covenant issues in the past few quarters. When banks lend companies money, they'll often build certain metrics into the loan agreements, dictating that the company must meet certain revenue or earnings goals so that the banks are comfortable that they'll eventually get paid back. The growth targets built into Allegiance's original credit lines simply proved to be too high in the aftermath of economic hard times and the collapse of IT spending. Most of the start-up service providers have run into similar problems, because most expected the boom of the late '90s, when they drew up the agreements, to last forever. Allegiance is one of the few remaining survivors.
So Allegiance successfully renegotiated those bank covenants and announced the new agreements with their banks on Nov. 27. The banks' willingness to renegotiate those covenants is just about where the good news ends. As part of the renegotiation, the banks are requiring Allegiance to reduce its outstanding debt from $1.2 billion to $660 million. The easiest way for Allegiance to accomplish that would be to raise more capital from issuing stock. But given Allegiance's share-price decline of more than 99% in the past year, that's not really possible now.
Breaking the Bank?
The good news is that most of the debt is trading at about 20 cents on the dollar. The company shouldn't have much trouble buying that debt back, as most debtholders (like me) who bought the debt near current levels would be more than happy to sell it back at a decent premium, probably at least 25% to 50% higher than these levels. The company made all of its debt payments on the bonds through the end of last year. The bonds would make for a good return indeed if Allegiance can figure out how to buy it back.
The bad news is that Allegiance will certainly have to issue some sort of convertible and/or stock to raise the cash to get those debt levels to their targets under the new bank covenants. Shareholders all know it's coming; the company said so in its recent press release (issued only two hours after a much more positive press release touted an agreement between Allegiance and Level 3 LVLT ):
"This debt reduction may include the issuance of new equity or equity derivative securities for cash to retire outstanding debt, the use of cash to retire outstanding debt or the issuance of equity or equity derivative securities in exchange for outstanding debt."
"May," of course, is the operative word.
I've spoken at length with several folks inside the company, including CEO Royce Holland, but I just can't figure out any concrete solution that wouldn't leave shareholders with basically nothing.
It's too bad that the stock has fallen to these penny levels, as a rising price could've created a virtuous cycle. For example, look what transpired recently at American Tower AMT : After the stock rallied from 60 cents to $5, the company was able to deal with a nasty and complicated convertible issue. Holders of the convert were going to be able to force the company to buy it back from them, but the company was able to issue new debt and warrants that weren't so terribly dilutive. The deal still wasn't pretty for shareholders or for the company's balance sheet, but it was at least doable after the big rally.
The biggest shame of this balance-sheet debacle is that Allegiance really has done a great job of running the operations side of its business. Revenue has consistently grown, and the company executed very well on its viable business model as a competitive local exchange carrier. It's one of only two companies to successfully pull this off. (The other was privately held Broadview, where I once worked.) Even the pending FCC changes won't kill the model: Allegiance owns and operates its own switches and therefore won't lose the ability to continue selling its services.
Alas, that won't be enough to keep shareholders happy. However, I still think the bonds have some allure, as bondholders will likely be bought out at higher levels or will end up with a substantial part of equity in a good company. |
