FOOL ON THE HILL
An Investment Opinion
In the past week, the company has announced the resignation and replacement of the Chief Operating Officer, a new Chairman of the Board, who is also serving as the interim Chief Executive Officer, and announced its annual operating results for 1999, replete with some dreaded restatements.
The first two issues show a good deal of management churn at the company. They are of concern, but given the financial condition that e.spire finds itself, it's not all that surprising that changes at the top have been made.
The company's poor financial condition is the rub, however, and it just got a whole lot worse. e.spire was originally scheduled to release its earnings report yesterday, but delayed this announcement pending review of the financials by the new officers at the company. In lieu of its earnings release, the company did put out a preliminary report, and it did not paint a pretty picture. Two items stood out: first, that the company was having to restate earlier reported earnings for 1999, and that it had failed to meet some of the covenants of its senior secured credit facilities of $200 million. This means that the company either failed to pay its debtors, or, since the credit facilities are secured by assets or earnings from e.spire, that its operations failed to meet the securitization requirements by the note-holders. This is a bad thing for any company, but is particularly worrisome for one in a capital-intensive business with significant losses from operations.
Some investors have reacted to these new developments with e.spire by rushing to the exits, nearly halving the stock price in the process. There are several lessons here, but one is that the problem with creditors is significant enough that investors with lower-risk profiles are absolutely right in their decision to bail on the company. The reason for this is not related to e.spire's ability to rebound, because, as I have opined before, the company is fairly unique in its approach to providing local telecommunications access, and as such has absolutely remarkable potential. But this is a business with huge financial and technological barriers, not so much to entry, but rather to eventual success.
For the fourth quarter of 1999, e.spire announced that its revenues would be in the range of $55 million, with an EBITDA (earnings before interest, depreciation, and amortization) loss of $35 million. This represents significant growth in revenues, around 56%, over the prior year, but also shows in sharp detail the continued loss from operations being sustained by the company. Given the enormous cost of building out the local loops, this level of loss is not surprising. CLECs that choose, as e.spire has, to build out plant all the way to the customer have extremely high costs per acquired customer. With 56% annual revenue growth and a 45% sequential growth in number of subscriber lines, e.spire's capital requirements have been huge.
But e.spire also has an accounting discrepancy to deal with, which requires it to revise 1999 revenues downward by $12 million. At issue is e.spire's treatment of sales of "dark" fiber (fiber optic cables that are deployed but not in use) as outright sales with bookable revenue rather than as a long-term lease, as the Financial Accounting Standards Board (FASB) has dictated they should be treated. So e.spire booked its revenues on a sale basis, meaning that the proceeds hit the balance sheet immediately, instead of treating them as leasehold revenues, which are booked over the life of the contract. This is not the largest component of e.spire's business, but any discrepancy of this nature is a valid reason for concern on the part of shareholders.
Of larger concern is the fact that e.spire has failed to meet some of its covenants with the lenders of its secured credit facility. This is a big red flag for any debtor company. Not only will the company have to renegotiate with the existing lenders, but also it can expect more stringent covenants and higher cost of debt capital due to the perceived increase in risk. e.spire had $63 million in cash on hand as of December 31, 1999, and has access to other credit facilities. But with its current cash burn rate it has less than one year of operating capital on hand. Should e.spire's financing options dry up, superior technology or not, the company will be in big trouble. Finally, one of the big dangers with companies that have multiple financing agreements is that by breaking covenants with one creditor, they may begin breaking the terms of other creditors as well.
e.spire has contracted with Morgan Stanley to help it explore options for raising additional capital, including even selling off some nonessential assets. The company did say that it had completed the buildout stage of its operations and is now moving to turning profitable.
This company remains the high-risk investment it was before, only now at least one of the risks, its ugly cash flow situation, has just turned a bit darker. The company has a top-notch service and has the benefit of maintaining almost all of its customer base "on-net" (on its internal network rather than over leased lines). I'd expect that these points will help keep the creditors' pocketbooks open to e.spire, but their cost of capital is certainly going to rise.
TMFOtter on the Fool Message Boards