Moody’s downgrades debt for XO, McLeodUSA

Moody’s Investors Service lowered the debt ratings of two CLEC survivors, casting doubt on the carriers’ abilities to fund themselves beyond 2001 and making it more expensive for either company to tap the debt markets.

Moody’s lowered McLeodUSA’s senior unsecured debt rating to “B3” from “B1,” its senior secured bank rating to “B2” from “Ba2,” and its preferred stock rating to “caa” from “b3.” The outlook--an indication of possible future rating changes--remained negative.

Moody’s said the lowered rating reflects its concern that McLeodUSA’s revised business model may be further impacted by the “general economic slowdown” and by the “broad-based scaling back of its customers’ telecommunications spending plans.”

According to Moody’s, it is questionable whether McLeodUSA will be able to generate the sustained EBITDA growth needed to cover “intermediate” funding needs.

Although McLeodUSA had $1.1 billion in liquidity at the end of the first quarter, including a $725 million secured bank facility, the carrier will need a “sustained increase in EBITDA” in 2002 to cover its projected capital expenditures of $400 million and about $330 million in interest expenses, Moody’s said.

Despite the downgrade, Glenn Waldorf, CLEC equity analyst at UBS Warburg, retained his “strong buy” rating on McLeodUSA shares. According to Waldorf, McleodUSA has “the levers in place to lift its EBITDA upward.” The drivers of the carrier’s EBITDA growth will be improved margins on its acquired businesses, Splitrock and CapRock Communications; increased salesforce productivity; increased revenue per customer; and the activation of McLeodUSA’s fiber network within its 25-state footprint, Waldorf said.

“We remind investors that McLeodUSA’s core customer base is small and medium enterprises in rural markets to whom the company primarily provides voice services,” Waldorf said in a research note. “These customers are not shutting off their telephone lines.”

Highly leveraged XO Communications was also downgraded by Moody’s.

Moody’s dropped XO’s debt two notches, affecting more than $6 billion worth of debt. The carrier’s senior unsecured and issuer ratings fell to “Caa1” from “B2”; its senior secured and senior implied ratings dropped to “B3” from “B1”; and its convertible subordinated rating was lowered to “Caa2” from “B3.” The ratings outlook remains negative.

According to the downgrade notice issued by Moody’s, the negative outlook reflects its belief that “XO will be constrained in its ability to cover its future funding gap on acceptable terms and may still be further impacted by the general economic slowdown.”

Despite a $250 million equity infusion from Forstmann Little and a change in its business plan that shaved $2.0 billion from its capital budget, XO will need another $750 million to reach positive free cash flow, Moody’s said.

Waldorf retained his “hold” rating on XO stock.

“We believe equity investors should wait for the proof that the company is able to generate sufficient cashflow to meet its high fixed-interest payments before returning to this name,” Waldorf said.

Waldorf forecasted XO’s 2003 EBITDA to be $339 million, significantly less than the company’s $400 million in cash interest payments due that year.