McLEOD BONDHOLDERS TO DECIDE: LITTLE NOW OR CHAPTER 11 LATER

Most don't like this $100 million deal, but bankruptcy may be worse

Ted Forstmann is playing hardball with McLeodUSA's bondholders, who have resisted the $100 million debt restructuring deal for the competitive carrier that Forstmann's investment firm laid on the table. But McLeodUSA has offered a little New Year's incentive: It stopped making the interest payments as of Jan. 1, putting it on a 30-day crash course for Chapter 11 bankruptcy. If the bondholders don't step in line with Forstmann, analysts say they could be left with nothing.

Forstmann's deal, which would eliminate almost all of McLeodUSA's $2.9 billion in debt, gives bondholders approximately a dime on every dollar in debt plus equity stakes in the carrier, according to analyst estimates. But bondholders hinted they might hold out for bankruptcy, bandying projections of 19¢ on the dollar — the return Covad Communications bondholders received when the CLEC filed for Chapter 11.

Then Winstar Communications went bankrupt.

Last month, IDT finalized a deal to acquire $5 billion in Winstar operating assets for a mere $42.5 million in cash and stock. “The Winstar settlement set the tone for all future bankruptcies,” said John Laprise, analyst for New Paradigm Resources Group. “As bondholders of failing CLECs go, [McLeod shareholders] are making out like bandits.”

William Blair & Co. CLEC analyst Ken Kotylo was not surprised that McLeod halted its interest payments because the bondholders didn't immediately jump on Forstmann's offer.

“If they were to continue to make interest payments, the bondholders wouldn't have any incentive to reach a deal,” Kotylo said.

Forstmann Little, Forstmann's investment firm, already has invested $1 billion in McLeod, giving the investment firm a 12% stake in the carrier. In August, McLeodUSA announced an additional $100 million infusion. The deal was not completed, but Forstmann did re-engineer the company's board and executive ranks.

Forstmann made himself chairman of a newly created executive board and offered his deal again in December, this time severely watered down. Instead of a 20% stake, Forstmann Little would get 45% of the company at the same price. And for an additional $535 million, the firm gets McLeodUSA's directory publishing business — a unit the carrier previously said was off the negotiating table.

The deal has drawn comparisons to the one Forstmann made with XO Communications, in which Forstmann offered to pay $400 million in cash and eliminate most of its debt.

The big difference between the two deals lies with the shareholders. To come up with Forstmann's 39% equity stake, all outstanding shares of XO will be diluted into worthlessness. McLeodUSA's shareholders aren't being wiped out. However, in both cases, the carrier would emerge with a clean balance sheet and Forstmann running the show.

“You're beginning to see a phenomenon we saw back in the 19th century, when wealthy tycoons began buying up railroads,” Laprise said. “Ted Forstmann may be the first of a new wave of telecom robber barons if these companies he's buying into are able to make it.”

A TALE OF TWO FORSTMANN DEALS