C&W's Share Price Shrinks

Cable & Wireless (NYSE: CWP) shares are sinking like an undersea cable, following Friday’s announcement that Moody's Investors Service had downgraded the company’s debt to junk status (see Moody's Downgrades C&W).

On Monday, the company’s shares trading on the London Stock Exchange fell nearly 43 percent, plummeting almost 36 pence to a year-low of 48.45 pence, or about 77 cents. The company's ADR (American Depositary Receipts), trading on the New York Stock Exchange, fell $1.57 (40.26%) to $2.33.

As the harsh market reaction indicates, the downgrade was not only an affront to C&W’s reputation. It also triggered a clause in an agreement the company signed with Deutsche Telekom AG (NYSE: DT) in 1999, which could make it liable for as much as £1.5 billion, or about US$2.36 billion, in taxes -- a substantial chunk of the company’s £2.2 billion cash reserve.

The revelation of the clause, which threatens to tie up nearly 70 percent of the troubled carrier’s available cash, caught stockholders and industry observers by surprise. “There are lots of games being played,” says Craig Johnson, an independent analyst based in Portland, Ore., saying that C&W should have revealed the potential tax liability earlier.

Whether or not C&W will have to pay out the amount remains to be seen. Company officials are still painting the scenario as remote. “The advice we have, and our firm belief, is that there is no tax liability,” says C&W spokesman Peter Eustace. However, he admits, it could take several years before the question is decided.

C&W, however, defends its decision to keep the clause quiet, stating that it was under no obligation to do so before the requirement was triggered. "Up until now, it’s been considered such a remote possibility that there was no requirement to announce it,” Eustace says.

When C&W sold its 50 percent stake in wireless company One2One to Deutsche Telekom for £3.45 billion, or about $5.4 billion, the German carrier insisted that C&W set aside £1.5 billion for potential tax liabilities in case its ratings fell below investment grade.

That happened with the Moody’s downgrade on Friday, and now C&W is in talks with banks to seek a £1.5 billion guarantee that would help it cover the potential liability. Without such a guarantee, the carrier will have to dip into its cash reserves, placing the money in an escrow account until the tax issue is settled.

The news was the last in a long line of negative announcements from the company. Last month, the carrier announced that it was slashing 3,500 jobs and was closing nearly half of all its data centers in the U.S. (see C&W Preparing to Sell US Network?). Standard & Poor’s also downgraded C&W last month, and today the rating agency reiterated its negative outlook, saying it was disappointed by the disclosure of C&W’s tax indemnity agreement (see C&W Still on Watch Negative).

The company has about £1.6 billion in debt, most of it in bonds. About £1 billion of that will be due next year, according to Eustace. He laughs off the possibility that the company could be forced to file for bankruptcy. “My understanding of the definition of bankruptcy,” he says, “is that you owe more than you’ve got… We believe that we’ve got the flexibility to implement the [planned restructuring].”

Analyst Johnson says he thinks what’s happening with C&W is symptomatic of the entire European market. “I think we’re just starting to see the tip of the iceberg in Europe,” he says, pointing out that Europe generally trails the U.S. market by 12 to 18 months. “The ugliness of it is really just coming to the surface.”

— Eugénie Larson, Reporter, Light Reading