Wow, while I was writing up my model, Level 3 dropped a bombshell. The company announced commitments for $400M in debt from a group of holders ranging from top shareholders Southeast Asset Management and Fairfax on down to board members Walter Scott and Robert Julian. Simultaneously, they issued tenders for their 2009 and 2010 convertible debt, currently trading at various discounts. Where to start? They totally surprised me, I expected the company wouldn’t make a move for a while yet. Others did see signs recently that the company had a refinance in hand, congrats to them.
They clearly couldn’t have raised this money from anyone other than interested parties, some of whom were buying stock in October. The money is clearly expensive, at 15% cash interest and convertible at a price of just $1.80. However, they will be buying back debt at a discount, which will reduce the pain somewhat – and that is clearly a big part of the plan here. If they take the full $400M, that would be an extra 222M shares of stock. Equity friendly? If one asked 6 months ago, the answer would have have been quite different. Today? I think the market was expecting much worse.
So where does this put them? Well, if they do buy back the $571M in face value of debt that they want to, it looks as if they will have face value of about $152M due in 2009 and $418M due in 2010, which adds to $570M in maturities – conveniently just below their current unrestricted cash balance. I doubt very much that is an accident, the line from here will be that they no longer need to raise money anytime soon because they are FCF positive and have enough cash to meet their maturities.
But that 15% debt, that’s $60M per year in interest, and the converts they are paying off were costing $27M in interest – so FCF takes a $33M or so hit. That shouldn’t be enough to derail current FCF trends, assuming the economy doesn’t get even worse. It remains to be seen though if they can get their debt at the discount they are offering. Just making this deal may change the prices, and I don’t know how much. On the other hand, a lot of debt holders need cash these days… This deal isn’t done yet, we will just have to see how it turns out in the end. But the financial wizardry of LVLT continues to amaze, who would have thought they could find $400M in this market?
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Categories: Financials · Internet Backbones
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Nothing makes any financial sense anymore
Well, it would have been cheaper to wait and progressively buy back the bonds with cash at discounted rates. But there must have been an opportunity cost in doing so. It suggests to me that they are planning to execute on what they’ve said all along they plan to do: make more acquisitions once Unity is locked down. If this tender is successful it will reduce debt, raise the stock price and position the copany for an equity-friendly dilution to finance an M&A.
I agree, this would seem to clear the deck for future M&A. They had to refinance first for that to happen. Global Crossing anyone?
This is happening across the industry as we speak. While little has been announced many companies with debt are turning the tables on debt holders who desperately need cash. Companies that can get liquidity can clean up their balance sheet.
The reality is that investors, not companies, are the ones that are really hurting.
I suggested last night that Jim go to the government for a better deal than these harder money lenders! Make no mistake about it, they are hard money lenders! And Jim Crowe complained about Buffett being “expensive!” He should have applied within TARP or found some other loop hole like the autos are trying to do. American tax payers would have been better partners and benefactors of the great rewards this network is certain to spill out, one day. 🙂
The entities providing the $400mm financing already own about 60% of the stock of LVLT. The company can force conversion at any time at $1.80. Assuming LVLT can retire the outstanding debt at 65 cents on the dollar, the cost would be $750mm and the interest savings would be $60.5mm or about the same amount they would pay for the $400mm in financing.
These controlling shareholders are far more interested in what happens to the value of their equity. Very positive for Level3.
The assumption that they get all of it is probably a bad one. And, that would vastly reduce their current “restricted cash” to something like 200M, or not a whole lot of cushion.
On the bright side, they probably don’t expect to capture it all, and/or they’re very confident of positive free cash flows into the horizon even while excluding the next acquisition target.
Of course, that next target should really fall to the bottom line, this time, right?
Make that “unrestricted cash” since we’re still “restricting” a lot of valuable cash as a result of “coal mines.”
Albert Upsher,
Do you think these friendly “equity” investors, at least the institutional ones, might begin shorting these potential 222M shares that may be issued in the future?
If/when the stock goes above 4.00 for 20 trading days —- it forces an immediate conversion—- the 220 mil sh are issued,the 400 mil in debt disappears & the co adds 60 mil to F/C/F positive .
Expensive , but LVLT never waits to the last minute— they always move early to solve financial problems . Being sure that the downside is protected [bk] , has always been their modus opperandi .
Carlk,
I am not sure I understand why the equity holders I am refering to would do that. Prem Watsa who controls Fairfax Financial Holdings has been 70% in cash and government securities for over a year after having made a lot of money betting against the US housing and financial markets. He began buying LVLT in Q4, 2007 and now owns 10.2% of the common and on October 14th filed a Form 3 declaring a benificial interest in the 9% Convertibles of 2013. Steelhead Partners has increased their equity position from 3.36% to 5.2% buy exchanging convertible debentures for stock.
Southeastern Asset Management and the Longleaf Funds they manage have been holders of LVLT for several years and control 42.28% of the common stock. These three entities either directly or through owning the convertible debt in the case of Fairfax control about 60% of the common stock.
As the chairman and ceo of Cisco said buying Cisco is a bet on the internet.
It is my feeliing that Prim Watsa and the other major holders feel the same way about LVLT, and realize that rationalizing the financial structure is critical to its long term success.
Cisco is projecting a 600% increase in internet traffic between 2007 and 2012 with online video as the biggest driver of this increase.
Either you believe Jim Crowe when he says the most cost effective way to move anything digital is over an IP Optical network or you don’t. That’s what makes a horse race. I think Watsa et al believe Crowe is correct.
Albert,
I don’t disagree with what you’re saying especially since it’s part of my own investment thesis, unfortunately, for way longer than those investors who you are citing in your post. And, without any pay while you wait incentives at the door. Let’s call them door prizes for this exercise.
For example, there have never been conversions to the degree which these characters have been able to usurp for non preferred, rank and file shareholders.
It looks like FFH got a compounding effect too, with those last 42M shares, at significantly higher conversion rates than indentured before committing to this loan. I don’t believe we removed enough DEBT(108M by memory), to take on the dilution they put in his pocket.
Talk about “expensive” money!
Moreover, Hamblin Watsa is not opposed to shorting, and the control size of these institutions collectively is potentially long term negative for LVLT. It’s a built in CAP. I have always considered SEAM’s stake size as a large risk, and now that applies to Fairfax as well.
I’m looking forward to some meaningful SEC regulation where these institutions must report their “short stakes” in addition to their “longs.”
The saddest part of this whole story remains the fact that, LVLT sells DEBT better than anyone on the street, while they can’t sell enough communications services to meet Crowe’s vision quickly enough. Of course, the price of that debt is expensive and the dilution continues to be dear. 🙁
They should sell this company for the value they suggest exists in their slide show presentations instead of continually serving up fat pitches to control freaks with very expensive terms attached to their self interests only.
Gents,
How do we go from $3/share to <$1 without any significant reduction in the short holdings? Even after the debt purhase announcement it looks like the large short position will remain even though near term threat of bankruptcy is gone.
I’m sure the Sept-Oct. drop was a significant profit taking opportunity for the shorts. So are they re-shorting after taking the profit? Isn’t there better short or long opportunities elsewhere in this market after all the recent destruction?
I guess Prem Watsa is no Warren Buffet because his investment in LVLT has done nothing ‘short’ of anything.
Tortellinboy,
Do you have a recipe for the answers to your questions? 🙂
If the float continues to be narrowed by the controlling interests, how much will be available if the controlling interests want to maintain a tight fisted approach to their shares?
It seems that the recent buys by those same institutions are nearly as much as the SI both in # and percentage terms.
The answers to these questions are better proposed to the Wall Street “store keepers” and regulators, however.
This is the most manipulated security I wish I never have to experience in my lifetime, not because it breaks EMT rules, but because the broken rules only go in ONE DIRECTION. 🙁