FORSTMANN, SLIM FASHION NEW DEAL FOR TROUBLED XO

Bailout means shareholder stock will become virtually worthless

It's hard to imagine more unlikely partners than financial wunderkind Ted Forstmann and Mexico's telecom mogul Carlos Slim Helu. But if all goes as planned, the two old friends will soon share control over troubled XO Communications. Forstmann and Slim and their respective companies, Forstmann Little and Telmex, are orchestrating an $800 million financial bailout of the metro carrier designed to wipe out the majority of its $5 billion debt and fully fund the company.

In doing so, both companies will take a combined 78% stake in the carrier, leaving bondholders to feed off the remaining equity stake and completely edge out stockholders whose common shares will become practically worthless.

XO and Forstmann Little officials did not return phone calls last week seeking comment. Telmex said in a statement that it is interested in an ownership stake because it believes with a restructured balance sheet, XO can survive.

Analysts believe Telmex may be using the deal as an entry point into the U.S. carrier market. Slim, who sits on a growing telecom empire in Latin America, has been trying to expand into the U.S. in recent years. Slim's primary U.S. holding, Prodigy Communications, was sold to SBC Communications, leaving Telmex without its U.S.-based ISP but putting it on good terms with partner and border neighbor SBC Communications.

“[Slim's] looking for the opportunity to expand Telmex's portfolio into the U.S. and perhaps eventually work with XO directly in Mexico,” said Marta Kindya, Latin America analyst for The Yankee Group.

The complex restructuring deal dilutes XO's stock with billions of new shares, most of which will go to Telmex and Forstmann Little. The remainder will go to an equity-cash package XO plans to offer bondholders, erasing all but $1 billion of its debt.

“Shareholders holding a few thousand shares are still left holding those few thousand shares as the stock gets seriously diluted,” said Ken Kotylo, a financial analyst for William Blair & Co.

The move will drastically remake XO's ownership. UBS Warburg analyst Glenn Waldorf estimated the deal would create the equivalent of 40 billion new shares, nullifying the value of 430 million shares now outstanding. Even Forstmann Little's previous $1.5 billion in investments will wash out in the ensuing flood, and XO founder Craig McCaw's 19% stake in the company will essentially evaporate.

There is a caveat to the deal, however. An agreement with the bondholders must be reached by Dec. 14 or Forstmann and Slim will pull their $800 million. According to Waldorf, the bondholders won't be an easy sell. “You're talking about 6¢ on every dollar in equity here,” he said. “The bondholders are essentially being told by XO ‘We have a new deal. Take it.’”

If an agreement isn't reached, XO will find itself in precarious position. XO said last week it would not make interest and dividend payments on its unsecured notes and preferred equity securities, a default that could drive the company into bankruptcy.