For a company that just ascended from bankruptcy, MCI (NASDAQ:MCIP) still has a lot of debt on its ledgers -- $5.9 billion as of its most recent 10-Q. It also has a substantial cash pile, $5.6 billion. Now that the S&P has assigned a non-investment grade of B+ to MCI corporate paper and senior unsecured notes, the question is whether the company will use some of the assets in column B to lower its exposure in column A. This is not ideal.
MCI's indentures have what is called a "reset" feature on them. If both S&P and Moody's (NYSE:MCO) rate MCI's corporate debt below investment grade, then the interest rate that the company pays on them may increase by as much as 2%. With the company's capital structure so heavily levered, such an outcome would cost MCI millions (about $60 million per 1% per year) in increased financing costs each year on existing debt. It would also substantially affect the attractiveness of additional financing for the firm, which S&P thinks that MCI will pursue to fund stock buybacks as well as its bodacious 8% dividend, the latter of which costs the company $127 million per quarter.
As Philip Durell noted when he selected MCI in the Inside Value newsletter, this company isn't exactly the highflier it used to be. MCI dominated the telecommunications business, particularly the legacy long distance voice segment, along with AT&T (NYSE:T) and Sprint (NYSE:FON) for the better part of the 1980s and 1990s. Overconfidence in the mid-1990s led to overcapacity, which led to overcapitalization, which led to a large number of bankruptcies, including that of MCI itself in 2002. With the VoIP revolution in full swing, upstart companies such as 8X8 (NASDAQ:EGHT) and deltathree (NASDAQ:DDDC) are gnawing on the long distance cash cow, adding further pressure on these companies without really accruing much in the way of economic profits themselves. It should thus be no wonder why each of these former titans is seeking out partners for merger or acquisition.
MCI's shares barely budged on the news, while its bonds lurched higher. At the moment, MCI's senior notes due in 2014 trade at 106.5, which is a premium to face value. This leads to the other part of Philip's thesis on MCI: The company is priced as though a second collapse of the equity is probable. Given that MCI's plan is to limit its capital expenditures and pay out as much of its cash flows as possible to shareholders, all while dressing itself up for potential acquisition, I think that the bond pricing gives a much better picture of the staying power of the company. And when it comes right down to it, anyone who has been watching telecom for a while should not be surprised that there is still plenty of question about whether all of the capital dedicated to it will generate an economic return.
See also:
- Alyce Lomax' "Troubles in Telecom"
- Bill Mann's "Global Double Crossing"
Bill Mann owns none of the companies mentioned in this article. Interested in other value ideas from Philip Durell? Come take a free trial of Inside Value, and see where he thinks the market is leaving dollars on the floor for the picking!
