There’s Still Money in the Bank

Posted: 11/1998

The Bottom Line

There’s Still Money in the Bank

By John T. Mulqueen

Telecommunications costs a fortune. Incumbent carriers spend tens of billions of
dollars annually expanding and maintaining their networks. Newcomers have the same burden
when they try to ramp up their networks to crack open existing markets. And, Wall Street
has been more than happy to find the funds that carriers need, whether in the form of junk
bonds (i.e., below-grade investment bonds in polite terminology) or stock offerings. But
that all ended in August when the world financial markets went into a tailspin and the Dow
Jones and other stock market indices plunged. New debt and equity financing also came to

It is raising hairs on the necks of some competitive local exchange carriers (CLECs)
that are short of cash and planned to either sell bonds or equity to finance their network
development, analysts say. Companies that raised money earlier in the year or in 1997 and
have enough funds to carry their expansion plans into 1999 should be in good shape. Others
that were hoping to sell debt or equity this year may have a tougher going, unless they
can get bank financing. Industry executives, bankers and analyst say that banks and
institutional funds are flush.


Mike Bandzierz, managing director of Toronto Dominion Securities, New York, says that
his bank has $2 billion to $3 billion in loans committed to telecommunications companies
ranging from MCI WorldCom to CLECs. It recently partnered with Chase Manhattan and Goldman
Sachs to loan Vienna, Va.-based Teligent Inc. $800 million in secured financing.
"Telecommunications companies are very good credit risks. They have stable,
predictable cash flows," he says, noting interest rates are in the 8 percent to 9
percent range.

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Image: Telecom Sucks Up Bonds

Royce Holland, CEO of Allegiance Telecom Inc., the Dallas-based CLEC, agrees with
Bandzierz. "There is plenty of money available at reasonably attractive rates–10
percent to 12 percent–that are better than high-yield bonds," he says. With $485
million in the bank, Allegiance has enough money to build its networks in 18 of its 24
target cities, he says, noting that the company will look for vendor financing or banks
for the rest. Allegiance is operating in four cities now and expects to be in five more by

Bob Lazzeri, an executive with Daniels & Associates, a Denver-based firm that
advises telecommunications carriers on mergers and acquisitions, says that pension funds
and private investment funds are still willing to invest in companies with good

If the uncertainties in the financial markets continue for a long time, there may be an
impact on mergers and acquisitions and network construction, but so far it has not
happened, Lazzeri says. Daniels has done 58 deals in the first nine months of 1998
compared with 57 in all of 1997, he says.

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Under the Wire

Blake Bath, a telecommunications analyst at Lehman Brothers, New York, warns that some
CLECs and international long distance companies will run into funding problems by the
middle of 1999 if they cannot raise money. However, bank financing is one alternative, he

Holland says that Allegiance squeaked under the wire when it did a $150 million initial
public stock offering (IPO) and $205 million debt offering early in July. "We were
about the last fish under the net," he says.

Maybe not. Equant raised $768 million July 20 when it sold 30 million of common stock
to finance purchase of international circuits and develop its corporate infrastructure.
"The market peaked the week after our IPO," says Jim Armstrong, Equant’s
investor relations manager. "We don’t foresee the need to come to the market for
several years."

"There have not been any new issues [of telecommunications high-yield bonds] since
the second week of August," says Drew Hanson, an analyst at DLJ Securities Inc., New
York. "There were a number of potential high-yield financings on the calendar as of
the end of August. They are still on the calendar. But since there is no calendar, the
market is just in a wait-and-hold state."

Harry Resis, portfolio manager at Kemper High Yield Fund, Chicago, notes the only new
high-yield issue of any sort in September was a $1.4 billion sale of debt by Cal Energy,
which he calls almost an investment-grade utility bond that was not affected by any
international factors.

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Image: U.S. Commen Stock-Telecommunications Industry

The turmoil in Asia, Russia’s meltdown, President Clinton’s domestic problems,
elections in Germany and a slow turnaround in Japan all are contributing to the
uncertainty, he says. Interest rates on high-yield bonds are between 12 percent and 16
percent, Resis says.

Cyrille Conseil, vice president and senior analyst at Moody’s Investors Service, the
New York bond rating agency, notes that at the end of June interest rates on new junk bond
issues were 450 basis points (4.5 percent) over the rate on a U.S. Treasury bond. By
August the difference had risen to 650 basis points. "That is a big change," he
notes. "I am not sure a new issue could find a market now."

New carriers like to finance their operations primarily with debt and then fill in
their needs by selling some equity, he notes, adding that is the reason they tend to be
rated at the bottom of the investment scale.

The industry’s dependence on high-yield funds is not new. Junk bonds, in fact, have
been a major source of capital for the industry at least since the 1980s. MCI
Communications Corp., Tele-Communications Inc. and McCaw Cellular all were financed with
junk bonds. Many of those bonds were sold by Mike Milken, the head of Drexel Burnham
Lambert’s bond trading operation before his conviction for securities violations.

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Even without Milken, carriers continued to tap the high-yield bond market. From 1990
until September 1998, telecommunications companies sold $51.5 billion in high-yield debt.
Demand accelerated in 1996-1997, and went into overdrive in the first 81/2
months of 1998, reaching a total of $20 billion by Sept. 24. Telecommunications carriers
accounted for more than 38 percent of all high-yield issues sold in 1998, according to
Securities Data Corp., Newark, N.J. (See Table 1 on page 156.) Since 1990 $41 billion in
stock in telecommunications companies were sold. (See Table 2 on page 156.)

There are signs some companies expect the financial markets to improve. Covad
Communications Corp., the CLEC offering digital subscriber line (DSL) service, has filed
for an IPO of up to $143 million, and according to Sprint Communications Co., it will
offer some of Sprint PCS to the public in a $600 million IPO. Covad could not do that deal
today, but is positioning itself to be ready to do so when the market turns up, analysts

John T. Mulqueen is a freelance writer based in New Rochelle, N.Y. He can be reached

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