A giant struggle

Scenario: A large, established telecommunications company, facing the risk of further credit downgrades, is desperate to lighten the debt load on its balance sheet and pins its hopes on the IPO of a subsidiary. Meanwhile, the company's stock plummets, and the CEO fends off accusations that he's unfit to run the company. AT&T? Lucent Technologies?

Wrong. Try Deutsche Telekom, Europe's largest phone company, which, besides being a force in Europe, is close to landing on American shores with the pending acquisition of VoiceStream Wireless.

Burdened by acquisitions as well as expenditures in the UMTS spectrum auctions in Germany, the United Kingdom and the Netherlands, DT is over-leveraged, said Carlos Winzer, senior vice president for European Telecom at Moody's Investors Service. From December 1999 to December 2000, the German carrier increased its debt from about $35 billion to about $52.7 billion.

Furthermore, for the year ending Dec. 31, 2000, excluding gains on asset sales, the carrier lost about $1.59 billion. In addition, DT recently had to lower its 2000 net earnings to $5.5 billion from $6.9 billion, due to a $1.87 billion charge to write down the value of certain real estate holdings.

So the fire sale is on. DT has a debt reduction plan in place designed to dispose of assets in order to raise enough cash to reduce the debt load by about $26.9 billion this year. DT's CEO Ron Sommer said that he hopes to raise $13.9 billion of that through the sale of regional cable networks. A recent all-cash deal with Klesch-Liberty Media for a majority stake in six cable networks spread across Germany reportedly brought in about $4.3 billion.

Additionally, in conjunction with France Telecom, DT plans to sell about $2 billion worth of shares in U.S. carrier Sprint, of which both carriers own 10% each. DT also has real estate holdings to the tune of $16.07 billion and, like similarly troubled carrier BT, could put some of that on the market.

But DT's execution of the debt reduction plan in the appointed timeframe is doubtful, according to Winzer. In mid-February, Moody's changed its outlook on DT's debt to negative, having already downgraded the carrier's long-term debt in October 2000. “The valuation of some of the assets — including the IPO of the wireless subsidiary — is dropping by the day,” Winzer said. “The probability of them raising [the target amount] in this fiscal year is becoming more and more uncertain.”

Proceeds from the IPO of T-Mobile, DT's wireless division, are not likely to be available anytime soon to pare down debt or for use as a public currency to expand into Italy and France, two key mobile markets in Europe. The IPO of T-Mobile, originally scheduled for the summer of 2000, has been delayed indefinitely due to market conditions.

“Management continues to be committed to [the IPO] — however, there might be a point where it decides it is not economically beneficial for shareholders to go ahead with the IPO,” Winzer said.

Prospects of the deal happening soon didn't improve when the public debut of Orange, France Telecom's wireless arm, fizzled recently, raising just $6.64 billion for a 15% stake, well below initial valuation expectations.

But there was some good news out of the T-Mobile camp recently. DT said its mobile subsidiary will make a profit for the first time in 2001, based on a substantial increase in customers in Germany, Austria and the U.K., according to DT's management. T-Mobile also said its 20 million customers make it the market leader in Germany ahead of Vodafone, although, according to Gartner Dataquest, the two operators are neck and neck in terms of market share.

Heavy competition in Europe makes the successful completion of the VoiceStream deal — and the integration of a far-flung U.S. network — all the more crucial. “It gives [DT] a much stronger international footprint, which is something they've been lacking,” said Peter Richardson, chief analyst for mobile communications at Gartner Dataquest. “When you're delivering next generation services, there will be an increasing requirement to replicate a service profile in many markets. That will be extremely difficult unless you have a controlling interest in the local markets.”

Deutsche Telekom recently “sweetened” the takeover deal after VoiceStream shareholders got upset that they wouldn't receive a dividend from DT this year. VoiceStream shareholders will now get an extra 0.0075 shares for each share owned prior to the closing of the merger.

Despite the erosion in Deutsche Telekom's share price, VoiceStream management still thinks the deal is a great value for its shareholders. “The whole wireless equity sector has gotten beat up pretty bad since last summer. It does not change our view in terms of value in [the] transaction,” said John Stanton, chairman and CEO of VoiceStream. “Having gone through nine months of tortures in the regulatory process, that process is a valuable asset being two-thirds of the way through it, and we would not want to restart that clock.”

VoiceStream shareholders are scheduled to vote on the takeover on March 13, and the deal is expected to close by mid-year. “Our expectation is that the VoiceStream transaction will occur,” Winzer said. “The shareholders of VoiceStream might, however, want to renegotiate the terms.”

Telecom junk debt biting back

High yield telecom debt as percentage of total issuance

Telecom companies issued an increasing portion of the “high yield” or “junk grade” debt raised in the past five years, and telecom bonds now represent 23%, or $93 billion, of all the junk bonds rated by Moody's Investors Service. Moreover, many of the bonds sold are discount notes, or “zero coupon” bonds, meaning they don't pay interest for the first five years. After the interest-free years are over, however, zero coupon bonds can place significant cash demands on the issuing company. Of the $31 billion in zero coupon bonds issued in the late 1990s, $2.5 billion will start requiring interest payments in 2001, an additional $6 billion in 2002, and $10 billion in 2003. “The conversion of discount notes into ‘cash pay’ instruments will represent additional financial claims on emerging telecommunications companies,” said a recent report by Moody's global credit research department. “Many of these companies may not have achieved their network coverage goals and thus may not be generating sufficient cash to service debt.”
Source: Moody's Investor Service