DJ IN THE MONEY: Lucent, Convertibles And Debt Covenants
Dow Jones News Service ~ March 20, 2002 ~ 8:00 am EST
By Michael Rapoport
A Dow Jones Newswires Column
NEW YORK (Dow Jones)--It's one of the small mysteries surrounding Lucent Technologies Inc.'s (LU) travails in recent days: The company claims it has enough liquidity, yet it just raised another $1.75 billion that it admits it doesn't really need right now.
Lucent is having trouble on a few different fronts, but liquidity doesn't appear to be one of them. Buoyed by asset-sale proceeds and a convertible preferred-stock offering last summer, Lucent has $3.07 billion in cash as of Dec. 31, plus another $1.9 billion available to borrow on its bank credit line. That's nearly $5 billion of liquidity - an amount that should be more than enough to see Lucent through to renewed profitability, which has been delayed but is now expected in fiscal 2003.
So why did the company tap the credit markets for another $1.75 billion last week, through another offering of convertibles? Especially since that offering doesn't come without costs: It's dilutive to the value of Lucent's existing common shares, and it will cost Lucent more than $135 million a year in interest. All this to raise a pile of money that Lucent says it intends to leave pretty much untouched for the time being.
It's never a bad idea for a troubled company like Lucent to play it safe and stockpile more money than it thinks it'll need, of course. Lucent may just be prudently taking advantage of an opportunity to raise some extra cash - an opportunity that may be hard to come by, since the company's credit ratings are firmly in junk-bond territory. Frank Briamonte, a Lucent spokesman, said the convertible offering is "part of our overall strategy to make sure we have sufficient liquidity."
But maybe Lucent's reasons go beyond liquidity. Here's another possibility: Lucent may want to raise more money because it's concerned about its future ability to stay in compliance with the covenants on its credit line.
Lucent notes that it's currently in compliance with all its basic debt covenants - the ones for which a violation could constitute a default. But a side covenant has already caused Lucent some agita. Last week, the company was forced to delay its planned spinoff of its remaining stake in Agere Systems Inc. (AGRA) because it hasn't met a covenant requiring it to have positive EBITDA ( earnings before interest, taxes, depreciation and amortization) in the quarter before the spinoff.
And it appears there's the possibility of trouble to come with the basic covenants themselves - possible trouble that could limit Lucent's options in the months ahead and could have convinced Lucent that it would be smart to raise some more money now.
Here's the argument, twofold:
First: Beyond the positive-EBITDA requirement for the Agere spinoff, Lucent's banks require it to hit quarter-by-quarter minimum levels of EBITDA just to stay out of default. The target for the March 31 end of the current quarter, for instance, is EBITDA of negative $350 million. For the quarters ending June 30 and Sept. 30, the targets are positive $50 million and positive $150 million, respectively.
And therein arises the problem. Lucent is currently burning cash, and by its own admission last week, it isn't likely to get back to positive cash flow in its current fiscal year, which ends Sept. 30. In other words, it expects to have negative cash flow by the time its debt covenants are going to require it to have positive EBITDA.
Now, EBITDA and cash flow aren't quite the same thing - especially given the very specialized definition of EBITDA under Lucent's credit agreement, which adjusts for a number of things beyond interest, taxes, depreciation and amortization. But given this picture, it's certainly possible that Lucent could trip that covenant in the June or September quarters - and a covenant violation such as that could make it impossible for Lucent to borrow on the credit line. It's possible Lucent thinks that could be a problem, and so decided to get some money in its coffers now, while it still could.
So why doesn't Lucent simply borrow on the credit line NOW, before this problem arises? Well, that brings us to the second part of the argument: Borrowing on the credit line might itself leave Lucent in jeopardy of tripping a debt covenant.
For Lucent to spin off Agere, it must have a current ratio - current assets divided by current liabilities, basically - of at least 1.75 as of the end of the last quarter for which figures are available on the date of the spinoff. Right now, it's above that level; based on the company's Dec. 31 balance sheet, the current ratio is about 1.86. (That figure doesn't include certain adjustments required under the complex definition of "current ratio" in Lucent's credit agreement.)
But if Lucent borrows on its credit facility, that has the effect of decreasing its current ratio. For every dollar it borrows, a dollar of cash goes into current assets and a dollar of short-term debt goes into current liabilities. That's effectively a current ratio of 1 - and adding that to Lucent's balance sheet drags down its overall current ratio. Using the Dec. 31 figures, and holding everything else constant, about $1.1 billion worth of borrowing on the credit line would push the company's current ratio below 1.75.
If Lucent borrows too much on the credit line, then, it runs the risk of not meeting the requirements to spin off Agere - something it's now saying it expects to do on the basis of its results for the June quarter. Rather than take that risk, the company might have chosen to get money through the convertible offering.
Even if Lucent doesn't do any further borrowing, there's still a covenant risk. Lucent's operations burned through $408 million in cash in the Dec. 31 quarter. If it keeps up that burn rate for two more quarters - the current quarter and the June quarter - and everything else stays constant, its current ratio will be just barely over the 1.75 threshold.
Lucent spokesman Briamonte said Lucent was in full compliance with its debt covenants as of the end of the Dec. 31 quarter, and expects to be in compliance as of the March 31 end of the current quarter. But Briamonte wouldn't comment beyond that when asked if Lucent expects the same to hold true for future quarters.
So will the covenants pose a real problem for Lucent? The convertible appears to have resolved any concern that Lucent's current ratio will fall below the threshold needed to spin off Agere - but Lucent shareholders may want to watch the EBITDA situation. (To the extent they can, at least: Lucent hasn't provided much disclosure about its EBITDA or how it's calculated, though the company has said it's considering providing more.)
Liquidity, after all, can take you only so far.
-By Michael Rapoport; Dow Jones Newswires; 201-938-5976
michael.rapoport@dowjones.com
(END) DOW JONES NEWS 03-20-02
08:00 AM |
