CHAPTER 11 FILING BY XO PUTS FORSTMANN IN HOTSEAT

It's his company for the taking, but Ted Forstmann doesn't want it anymore. XO Communications last week filed for bankruptcy, but without the prepackaged $800 million restructuring deal Forstmann brokered in November. Instead, XO is dragging its would-be savior kicking and screaming into court.

Forstmann and partner TelMex, the Mexican carrier majority owned by Carlos Slim Helu, tried to rescind their equity-for-capital refinancing package earlier this month, claiming there was no foreseeable way XO could meet the terms stipulated in the investment agreement. XO, however, claims it is well on its way to meeting all of the agreement's closing conditions and plans to hold Forstmann to his commitment.

“The point is we have a signed contract,” said Todd Wolfenbarger, vice president of corporate communications for XO. “We signed it because we meant to abide by it, and we don't intend to terminate it.”

While Forstmann's investment company Forstmann Little didn't return phone calls requesting comment, documents filed in federal bankruptcy court in New York show that Forstmann and TelMex asked XO to release them from the contract. The partners said it would be virtually impossible for XO to meet all of their terms. Forstmann also claimed that the carrier's fundamental business had deteriorated and that it faced regulatory obstacles — two potential outs for Forstmann and Slim.

Ironically, Forstmann Little also had expressed concern about the company heading to bankruptcy, but XO was required to file for bankruptcy to fulfill the obligations of Forstmann's restructuring deal.

While XO's bankruptcy filing came only 10 days after Forstmann and Slim tried to halt their agreement, XO officials said the timing was coincidental. The agreement expires if it is not approved by Sept. 15, and because XO might face a protracted courtroom stay, it wanted to get its filing in well ahead of the deadline, the XO spokesman said.

However, XO may have other reasons to bring the Forstmann agreement before a bankruptcy judge as quickly as possible, said Bill Rochelle, a bankruptcy attorney for New York firm Fulbright Jaworski. Once the case is under the jurisdiction of a federal bankruptcy court, XO can seek to resolve all of its legal grievances before the judge. Most bankruptcy judges tend to be lenient toward debtors appearing in their courtrooms, Rochelle said.

“XO is trying to have jurisdiction in bankruptcy court to sue Forstmann if he backs down from his agreement,” said Rochelle. “This is a game we bankruptcy lawyers like to play all the time. A third party facing a major lawsuit doesn't want to find itself a defendant in a bankruptcy court.”

XO also has a backup in the form of a stand-alone plan, which essentially would put the company in the hands of its lending banks. Half of its $1 billion secured loan debt would be turned into equity, while the remaining $500 million would become junior secured debt. XO would pay interest on the junior debt only when the company reaches cash flow positive. The deal would put $200 million in cash in XO's coffers — a far cry from the $800 million offered by Forstmann — but would leave both bondholders and common shareholders with empty palms.

While the bank plan is a last resort for XO, it would keep the company in business after Chapter 11 if the Forstmann deal falls through. However, if XO can hold Forstmann and Slim to their proposal, there would be little incentive for the court to reject the package. More than two-thirds of XO's secured lenders have approved the package, and because XO management and the banks rejected an earlier restructuring proposal by financier Carl Ichan, unsecured bondholders are left with few alternatives. The banks' stand-alone plan leaves bondholders and shareholders with nothing, while Forstmann's plan leaves with them with a 20% stake in the restructured company and $200 million in cash in exchange for wiping XO's books of $4.5 billion in bond debt.

Given the number of service providers liquidating, an asset sale likely would leave an even smaller pool of cash to divide. In its bankruptcy filing, the company said it has assets of $5.7 billion, but in liquidation they could raise as little as $257 million.