Double-Dip Bankruptcy?

I used to like the phrase "double dip" back in the days when it meant ice cream. By now, we're all familiar with the term "double-dip recession," which is Wall Street's latest source of anxiety. This week there's a new usage to consider: the double-dip bankruptcy. That's the concern raised in an article this week in Light Reading.

"Many doubt that large-scale telecom tragedies will manage to transform themselves into feel-good stories with happy endings," writes LR reporter Eugenie Larson. "The other option is that the whole industry could devolve into a cyclical situation with repetitive bankruptcies, just like the airline business."

Yikes. The story cites a new report from i2 Partners titled "Telecom Distressed Assets: Bondholder Beware", which suggests that recent reorganization plans commit the same sin that put these companies into Chapter 11 in the first place - projecting future revenues from demand that hasn't materialized yet. The folks at i2 dub these "magic revenues."

"Revenue for high-growth, high-margin managed services assume unprecedented growth rates ... for which there is no pre-bankruptcy track record," the firm writes. Reorganizations counting on huge revenue growth in managed services should certainly get close scrutiny, especially given the prospect of a double-dip recession and the likelihood of depressed corporate IT spending.

But there are also plenty of bankruptcy plays that seek to tip the financial equation with a different cost structure. Many feature new owners picking up distressed assets out of Chapter 11 and moving ahead without the baggage of having pre-bankruptcy management still in place.

Either way, a single dip is fine by me these days. Even when it means ice cream.

Lenders As Owners

This morning's announcement by FiberNet featured an unusual wrinkle: the metro connectivity provider's bank lenders have agreed to convert $66 million owed under the company's senior credit facility into common stock. If the transaction is completed, FiberNet's bank lenders will wind up with 60 percent of the common stock and control of the company. It's the second example in a week of a data center services company using its common stock as a tool to try and eliminate debt, rather than raise cash.

Last week, Equinix said it's negotiating a deal in which it hopes to retire most or all of its high-yield "junk" bond debt using newly-issued shares of common stock. According to management, both the company's bondholders and bank lenders support the idea.

Are these desperate moves by lenders to salvage troubled loans? Or are bankers and bondholders becoming hard-core believers in the future of telecom?

It seems to be a little of both. Lenders can still be plenty fickle, as Pinnacle Holdings found out last week when a group of lenders including Fortress Investment and Greenhill Capital withdrew a funding package that would have brought the company out of Chapter 11, citing "current market conditions" in the telecom sector.

But lenders also see opportunity in situations where a company's management is taking aggressive steps to make the business work. FiberNet has done the requisite belt-tightening, and lenders may find a comfort level in president and CEO Michael Liss' experience as a former managing director at Lazard Freres and Bear Stearns. Equinix, for its part, has worked aggressively to reduce its debt, retiring more than $93 million in bank loans and high-yield bonds in the past year.

The flip side of these recapitalizations is the amount of new shares that will be issued. FiberNet, for example, is seeking permission to authorize up to 2 billion shares of new common stock (yes, that was a "b"). The impact on existing shares is found in the boiler-plate sentence that predicts "substantial dilution" in the value of the common stock - which is a polite way of saying "your shares will be worth diddley."

Yet in a Chapter 11 filing, those same shares would be worth less than diddley. Painful as they are, these restructurings keep the door slightly ajar for remaining public investors, most of whom clung to their shares as prices plunged, and would welcome any lifeline they can find.

It's a pleasant surprise to see that such lifelines are available - and coming from bankers. In the past two years, lenders have often decided to cut their losses and settle for whatever recovery might be possible through bankruptcy or liquidation. The going concern is looking like a better bet nowadays - one more sign of the industry's efforts to find a bottom and rebuild.

Bankruptcies Hit Hard

As WorldCom's fictitious earnings top $7 billion, the red ink is also mounting for its service providers and partners. Each new earnings report from a telecom or data center services provider adds to the pile of receivables left in limbo by WorldCom's bankruptcy filing. It's amounting to a huge challenge for those providers trying to stay out of Chapter 11.

Qwest assessed its WorldCom exposure at $119 million. The numbers are smaller at hosting and interconnection companies, but they often represent a bigger chunk of the revenue stream. Digex set aside a $12.5 million provision for hosting services sold through WorldCom's channel - representing about 27 percent of its hosting revenue.

Its not just WorldCom, either. Equinix took a $1 million hit from the Chapter 11 filing by Teleglobe, which had agreed to buy surplus equipment from Equinix. The bankruptcy court is now sending the equipment back to Equinix, which will try again to sell it but in the meantime will write down the entire $1 million to be fiscally prudent.

Universal Access saw its revenues decline $5 million - equivalent to a 17 percent revenue hit - following the bankruptcy filings by WorldCom and Metromedia Fiber Networks, its two largest customers.

These are only the publicly-held companies that have to report their exposure. Similar stories are undoubtedly accumulating among privately-held service providers and landlords. As the pain spreads, there's a ripple effect as companies cut costs to get more mileage out of their dwindling revenue streams.

What's Buffett's Telco Game Plan?

For a guy with an aversion to technology stocks, Warren Buffett is getting mighty busy in the telecom investing arena. Just two weeks after Buffett's $100 million investment in Level 3, his Berkshire Hathaway investment company is reportedly a big buyer of Qwest's bonds.

Is this another value play by Buffett, who is renowned for his eye for bargains? Or is it part of a secret plan to force Qwest into bankruptcy so Level 3 can acquire some of its assets for a song? The story in Denver Post, which is Qwest's hometown paper, openly speculates that Buffett may have an ulterior motive tied to his Level 3 connection.

Intriguing as those connections may be, I'm deeply skeptical that Berkshire's Qwest purchases are being done in cahoots with Level 3 CEO Jim Crowe. Buffett is famous for his discipline and consistency in sticking to certain kinds of investments. During the tech boom, Buffett took a lot of heat for refusing to invest in the technology sector. His rationale was simple: he invests in what he knows and understands, and he didn't feel he understood technology well enough to have confidence that his investments were wise.

That came at a cost. "We're perfectly willing to trade away a big payoff for a certain payoff," Buffett said at Berkshire's 1999 annual meeting. Three years later, history has vindicated Buffett's decision as the correct one for long-term buy-and-hold investors. Wall Street's tech euphoria proved a winning game for short-term market timers. That's not Buffett's game.

So what is his telecom strategy today? Does Buffett understand telecom well enough to commit Berkshire's money to a bottom-fishing splurge? My guess is that Buffett understands that the survivors of the telecom crash will be good investments over the long haul. He clearly believes Level 3 will survive, and has apparently decided that Qwest's odds of avoiding bankruptcy, along with the discount on its bonds, are tempting enough to take the plunge.