Thursday afternoon's downgrade of Marconi's debt to virtual junk status may have caught the stock market by surprise, but in the bond markets they'd been expecting it for a while.
Thursday afternoon's downgrade of Marconi's debt to virtual junk status may have caught the stock market by surprise, but in the bond markets they'd been expecting it for a while. The price of the £2.2bn of bonds the troubled group had sold to investors has been falling for weeks – and by late Thursday some of the bonds could be bought for half their face value.
"We've been anticipating a negative ratings move on Marconi on our high yield desk for some time," says Jeff Lubin, head of high yield at UBS Warburg. "We essentially don't have a telecom bond trading at par, in fact we don't have many telcos trading above 60c on the dollar."
Marconi is just one of scores of mainly telecoms companies which issued debt in a three-year long scramble for finance which is now leaving a trail of red ink and depression. One group, Atlantic Telecom, is facing a stand-off with its bondholders while another, Norwegian phone firm Enitel, filed for bankruptcy protections last week and a third, COLT Telecom, bought in some of its bond at a discount to their face value.
Finance directors all over Europe are fighting fires and previously high-flying firms such as Telewest, Energis, NTL, KPNQwest, UPC, Jazztel and Versatel, are facing tough decisions about how to deal with a new class of vulture investors which are swooping on the market.
A total of about £100bn of high yield debt was issued in Europe. The market only really got going in 1997 and continued well after the dot-com bubble burst – indeed some of the more troubled bond issues were only sold last year. This debt could be bought tomorrow for about £60bn. "Some 50 per cent of the European high yield market could be termed as stressed or distressed," says David Lofts, managing director of high yield at Banc of America Securities. "And about 60 per cent of the market is telecoms."
The definition of "distressed" debt is if it is trading at 80 per cent of its value or less. At the moment Telewest (whose £3.5bn of debt trades at between 70 and 80), Energis (trading at around 80) and COLT (whose debt trades as low as 65) are just about distressed. Cable groups NTL (trading at about 50) and UPC (trading in the 20s) are clearly troubled. Atlantic Telecom, where bondholders are calling for the company to be wound up, is trading at about 15 per cent of face value.
Few traders in London have experience of trading such securities. "There have been few distressed opportunities in Europe since the mid-1990s," says Mr Lofts. Gary Klesch has seen it all before. The urbane founder of finance house, Klesch & Co, was a major player in the distressed debt markets in the early 1990s when companies such as Brent Walker, Eurodisney, Eurotunnel, WPP, News Corporation and Canary Wharf were forced to restructure billions in debts. The companies largely survived, even thrived, but there were subtle differences.
He points out that most of the companies in the early 1990s crash had assets – lots of the TMT companies are now living on little more than a business plan. Second, the debt was largely owed to banks. Now the lenders are bondholders who often do not have to disclose their identity or can hide it behind nominee names. And third, there are many more companies and five or six times as much money at stake. But one key problem identified by Mr Klesch is that most of these bonds were issued under US – often New York state – law, largely because it was more convenient for the advisers and investors. However the companies, and what few assets they have left, are based in Europe. If the companies go under, or have to restructure, this could lead to a bitter legal fight.
One is already blowing up with Enitel, which filed for bankruptcy protection in Norway. In common with many other new-style competitive carriers, it was raising money before it had revenues, so it put some money aside to pay its first few years' interest payments. Though this money is supposed to be reserved for the bondholders, some of the banks have applied to the Asker and Baerum bankruptcy court to try and get hold of it. Though most bond experts think this could not happen under UK law, it could add to the worries when the telecoms companies come to restructure their debts.
And restructure they surely will do. Vulture funds such as Oaktree, Elliot, Moore and Goldman Sachs have already been seen snapping up debt. Their modus operandi is to go through the bond issue documents and the company's financial statements with a fine tooth- comb, trying to find anything that might breach the default clauses on the bonds. They then fire off a letter to the company demanding immediate repayment and plunging the group into crisis.
This is what has happened at Atlantic Telecom and bond analysts are saying the same could happen at UPC, NTL or even Marconi and Telewest. In a restructuring, everyone gets hurt. The banks are usually best off and the bondholders will only get a percentage of what they are owed. But if that percentage is higher than the "distressed" price, then the vulture funds make a profit.
But where does that leave the poor shareholders? "If bondholders are going to get hurt, equity-holders are potentially getting zero. That is finally getting reflected in share prices," argues Mr Lubin at UBS Warburg.