McLEOD BANKRUPTCY THREAT PUSHES BONDHOLDERS TO DEAL

Funding infusion gives Forstmann Little near majority control

On second thought, McLeodUSA will take Ted Forstmann's $100 million. Two months after saying it didn't need the money, McLeodUSA last week announced a deal with Forstmann Little that will infuse $100 million into the company, wipe out 95% of its $2.9 billion in debt and result in the sale of its directory business and the LEC it bought four years ago.

Forstmann Little, which already has $1 billion sunk into the carrier, would have a 45% ownership in McLeodUSA after the restructuring is complete. That's a significant jump from the 20% stake the investment firm was scheduled to take under the original deal announced in August.

But whether McLeodUSA can sell the deal to bondholders this week could depend on the carrier's ability to get the right price for the assets it plans to sell. McLeod also made the veiled threat of filing for Chapter 11 protection if bondholders don't accept the deal, which will give them about 19¢ on the dollar.

“The company and Forstmann offer is a good first step, but bondholders will be banking on a negotiation,” said Aryeh Bourkoff, high-yield telecom analyst for UBS Warburg.

Forstmann Little has agreed to buy McLeodUSA's directory publishing group for $535 million, which would provide most of the cash to pay bondholders. McLeodUSA estimates that the sale of its other asset, Illinois Consolidated Telephone, will bring in about $225 million to pay down additional debt.

Ironically, the two assets being sold are ones the company had previously said were off the table, said John Laprise, an analyst for New Paradigm Resources Group. “They're selling off their two most valuable assets,” said Laprise, who doubts McLeodUSA will get its asking price for the non-core parts of the company it will sell. “The market for equipment is too saturated with gray market equipment and almost new equipment.”

The deal drew immediate comparisons to Forstmann's proposed bailout of XO Communications, but it is different in two respects: McLeod is selling tangible assets, and its stockholders aren't being wiped out. Under the XO restructuring, shareholders were told repeatedly that their stock would be worthless. McLeodUSA shareholders will be diluted to a 30% ownership stake because of the newly issued shares going to Forstmann Little.

“The amount of cash Forstmann is putting into McLeod is insignificant compared to XO,” Bourkoff said. “Forstmann is also trying to play a role as an underwriter with McLeod.”

McLeodUSA said it would consider a pre-packaged Chapter 11 filing if bondholders don't accept the deal.

“With the state of the CLEC industry, the bondholders have to be reluctant to go into bankruptcy,” Laprise said. “If they're lucky, they might get in that [19¢ on the dollar] range. In certain respects, the bondholders are between a rock and a hard place.”

It's not an unfamiliar spot for CLEC bondholders. In October, Focal Communications closed a deal in which its bondholders exchanged $280 million in debt for equity representing 35% of the company's outstanding shares.

“The million-dollar question is whether this destroys the public credibility of the CLECs,” Laprise said.