The Credit Crunch of 2006 continues to unfold as companies who have debt and have delayed statements due to the options backdating scandal are vulnerable to having the debt called in early.
Hedge Funds Play Hardball With Firms Filing Late Financials
By PETER LATTMAN and KAREN RICHARDSON
August 29, 2006; Page A1
Hedge funds looking to extract bigger returns from the companies they invest in have come up with a new game of hardball: Fail to file a quarterly report on time, and they'll try to make you pay off your debt immediately.
Traditionally, when companies missed a deadline for filing their financial statements, bondholders would look the other way and let the company work out the kinks -- even though, technically, the company was in default and bondholders could demand repayment.
But return-hungry hedge funds and other big investors have found an opportunity to profit, thanks in part to a spreading scandal over the practice at many companies of backdating stock-options that were granted to employees as a form of compensation. That practice has come under scrutiny by regulators, and dozens of companies are having to review whether their earnings statements accurately accounted for such compensation -- which, in some cases, is delaying their filings.
In one of the largest recent examples, a group of UnitedHealth Group Inc. bondholders last week formally warned the Minnetonka, Minn., insurance company in a letter dated Aug. 25 that it is in default for failing to file its second-quarter report with the U.S. Securities and Exchange Commission. If it doesn't file the paperwork within 60 days, the group says it has the right to declare the bonds due and payable immediately.
The amount UnitedHealth would have to pay: $800 million, not otherwise due until 2036. Investors would stand to make a quick profit because UnitedHealth's bonds are trading below face value; if the company is forced to pay full value to redeem them, the bondholders who bought at below par would make a tidy return on their investment.
Other companies that have been targeted by bondholders for missing their filing deadlines include department store Saks Inc., truck and engine maker Navistar International Corp. and software maker Mercury Interactive Corp.
UnitedHealth's filing schedule was tripped up after the company was caught in the continuing options-backdating scandal in which executives at a number of companies allegedly doctored the prices of stock options to boost the pay packages of insiders. In May, UnitedHealth said it was the subject of a criminal probe by federal prosecutors in the U.S. related to the company's past stock-option grants. And on Aug. 10, it said it was delaying its filing with the SEC, citing the investigation.
"The company believes it is not in default and intends to defend itself vigorously," Mark Lindsay, a spokesman for UnitedHealth, said yesterday.
The backdating controversy, which so far has spread to more than 120 companies, has led to a record number of late filings. Some 138 companies with market values of more than $75 million each filed late reports for the second quarter, according to research firm Glass, Lewis & Co. Of those, 48 blamed investigations related to stock-options practices.
More bondholders are declaring technical default and either demanding immediate payment of debt or extracting substantial fees from the issuers in exchange for an extension of their default deadlines. Lawyers say acceleration of payment in one group of bonds could lead to a cross-default -- the forced acceleration of all of a company's bonds -- putting some cash-strapped companies at risk of bankruptcy.
"There used to be a kind of brotherhood of bond investors, where you didn't want to be the guy who turned the kid in to the teacher because he wasn't wearing a shirt with a collar," said Kirk Davenport, a partner at law firm Latham & Watkins in New York. But now, it is "outweighed by the desire to make a lot of money."
Andrew Redleaf is chief executive at Whitebox Advisors LLC, a $1.6 billion group of hedge funds that use the technical-default tactic. "Bondholders used to be extremely lazy," says Mr. Redleaf, whose firm holds bonds for both UnitedHealth and BearingPoint Inc., a consulting firm that also missed its filing deadline. "Part and parcel of what investors do is assert their rights, whether they're shareholders, bondholders or otherwise."
In the bond business, a standard indenture -- a detailed contract between an issuer and investors -- requires a company to file quarterly and annual reports with bondholders at or around the same time it files with the SEC. A company usually has 60 days to meet its missed filing deadline. Since a late filing is a technical default, so-called vulture investors, who typically buy bonds that trade at a discount to their face values, see a chance for a fast profit if a company can be forced to redeem at full value. The option-backdating probe, which has knocked down the bond prices of many of the companies being investigated, has provided a fresh opening for these investors.
Hedge funds, or private investment partnerships that cater to the wealthy investors, are fast becoming the dominant players in distressed-debt markets. But as they have proliferated, they are facing increasing pressure to generate outsized returns amid a sideways market.
With the number of delinquent filers on the rise, the trend could heat up. At least 25 companies during the past 18 months had their bonds accelerated in this way, or were forced to pay multimillion-dollar fees to bondholders, according to research by Merrill Lynch.
In a worst-case scenario for the companies being targeted, as part of the process for filing for Chapter 11 bankruptcy-court protection, bondholders and other lenders could end up taking over ownership, says Dan Arbess, head of Xerion Partners, a hedge fund that invests in distressed assets.
Vitesse Semiconductor Corp., for example, is in such a precarious position, analysts say. The company, which makes networking and telecommunications equipment, has less than $30 million in cash. That is far less than the $96.7 million payment that on Aug. 21 bondholders demanded to be accelerated.
The Camarillo, Calif., Vitesse, whose shares have fallen to about 85 cents from more than $3 in March, lapsed into technical default after failing to file its financial statements on time. Once a high-flyer, with a share price of more than $100 in 2000, it's been fending off activist shareholders who want to put it up for sale. Now, analysts are concerned that the company is in jeopardy from bondholder demands.
"We believe Vitesse does not have the financial strength to make these payments," and it could suffer a serious cash crunch "if this dispute is not resolved," says Allan Mishan, an analyst at investment bank CIBC World Markets.
Chris Gardner, Vitesse's chief executive officer, was quoted in a prepared statement as saying that the bond investors' demands "have exceeded anything that we would consider reasonable under the circumstances." Vitesse, which is currently in negotiations with bondholders, didn't return calls for comment.
In order to avoid default, some delinquent issuers have offered concessions to bondholders in the form of extra fees or better terms on the bonds. These include retailer Saks, Connetics Corp. and Bausch & Lomb Inc., according to the companies themselves.
The concessions can be costly. In July, software maker Mercury Interactive, one of the first companies caught up in the options investigation, said in a July 3 regulatory filing that because it failed to file financial results, Mercury had to pay $7.1 million to creditors, and grant them an option to redeem their notes at a premium, to ward off default. It may have to pay as much as an extra $40.2 million if creditors exercise the option.
Other companies that have missed filing deadlines as a result of backdating issues have begun negotiating with their bondholders. On Aug. 21, Sanmina-SCI Corp. asked its bondholders for an extension, offering financial concessions of $12.5 million. On Aug. 11, Amkor Technology Inc. announced that trustees for a group of its bondholders warned that if the company didn't meet an upcoming filing deadline it would be considered in default of its bond indenture.
In January, a trustee representing BearingPoint bondholders filed a lawsuit against the consulting firm claiming that it was in default on two of its bond issues because it missed an SEC filing deadline due to accounting issues. BearingPoint disputed the claim and said in a statement: "This is a cynical attempt to extract leverage, and we intend to contest this every step of the way."
Jeff Ross of Anthony, Ostlund & Baer, the lawyer representing the trustee against BearingPoint, says bond funds have a legal obligation to their own investors to enforce their rights. "Someone lending hundreds of millions of dollars to companies is entitled to accurate financial information."
Write to Peter Lattman at peter.lattman@wsj.com1 and Karen Richardson at karen.richardson@awsj.com2 |
