Vendor financing's dirty laundry

Vendor financing is an extremely sensitive subject for most equipment makers, especially with the fear that smaller carriers could go out of business.

In what appears to be the beginning of messy litigation, Winstar Communications last week filed a $10 billion lawsuit against Lucent Technologies, claiming the vendor defaulted on their financing agreement, which resulted in Winstar's bankruptcy.

The suit came after Winstar announced it missed making $75 million in interest payments on its senior debt facilities due April 16. In the same announcement, Winstar said Lucent had declared the fixed wireless provider in default of their agreement, a contention that Winstar disputed.

In fact, Winstar alleged it was Lucent that defaulted, having failed to make a $90 million payment to the competitive carrier on March 30.

“Lucent represented that it had the expertise, personnel and financial wherewithal to undertake its obligation under the supply agreement…. Little more than two years into the five-year agreement, Lucent has shown its promises were hollow,” said a section of the legal filing cited in Winstar's press release.

In the release, Winstar indicated Lucent cut off its financing because of scrutiny the vendor has undergone recently, noting that Lucent has stated publicly that it is actively managing its vendor financing portfolio.

While that may be a plausible interpretation of Lucent's statements, analysts say that the $10 billion petition brought by Winstar is excessive.

“Dream on,” said Scott Cleland, CEO of Precursor Group. “It sounds like a Hail Mary pass to me.”

Not surprisingly, Lucent rejects the claims of the lawsuit.

“This is absolutely frivolous and without an ounce of merit,” said a Lucent spokeswoman. “We did not breach any of our obligations to Winstar. The truth is they are in breach of their financial covenants, and they are in default.”

According to Dave Heger, a telecom analyst with A.G. Edwards & Sons who has followed both companies, it was through an unusual financing agreement that Lucent, a vendor, would give money to Winstar, a carrier.

Under the terms of their agreement, Lucent would help Winstar pay for other vendors' equipment if Lucent did not have a similar item, he said.

Another Lucent spokeswoman said the arrangement allowed Winstar to spend money from Lucent on equipment from other vendors.

“Our agreement with Winstar enabled them to make purchases with other companies where Lucent didn't have the products or services,” she said. However, that was not money that was owed, but that Winstar had “access” to it if it met conditions of the agreement, she said.

The spokeswoman declined to give further specifics on Lucent's financing arrangement with Winstar or the company's vendor financing practices.

Vendor financing is an extremely sensitive subject for most equipment makers, especially with the fear that smaller carriers, which are most likely to use such financing, could go out of business during the economic downturn.

However, statements made in October 1998 — when the agreement between Winstar and Lucent was announced — reveal a deal valued at $2 billion over five years, including network design and buildout services. At the end of last year, Lucent reported to the SEC that it had overall financing commitments of $5.7 billion and was in the process of finalizing an agreement worth $1.6 billion.

If the lawsuit continues, much of the information that Lucent keeps private could end up in public court documents.

“I'm sure they would prefer to keep the terms as private as possible,” Heger said. “Court documentation would expose a lot more of what's going on and how these deals are set up.”

Lucent may have used vendor financing aggressively to capture market share, said Mark Lutkowitz, vice president of optical networking research for Communications Industry Researchers.

“Probably back in ’98 there was a push for Lucent to show they were making penetration into the market other than AT&T,” he said. “How do you do that? You fund a carrier with vendor financing.”

The news coincides with Lucent's struggle to turn itself around after quarters of dropping earnings and rumors of bankruptcy. According to Heger, the default of loans it has made to carriers will hurt the company's balance sheet but likely will not affect its cash flow.

Winstar is not viewing its current situation as the end of the line. The company plans to reorganize and continue business under Chapter 11 bankruptcy, thereby lowering the debt on its balance sheet. It continues to serve its 30,000 business customers. Winstar maintains its restructuring plans do not depend on the success of the lawsuit.

The environment at the company will be different. Earlier in the month Winstar laid off about 2000 employees — most on the network build side — indicating it will focus on securing customers that its network already reaches rather than continuing its buildout, according to a statement from William J. Rouhana, Winstar's chairman and CEO.

“During the restructuring process, we will focus on maximizing the untapped potential of the 140,000 addressable businesses in the 4800 buildings that are directly connected to our already existing, domestic built-out broadband network.”