Optical/IP Networks

Is Lucifer in Lucent's Debt Details?

Imagine a document 257 pages long, weighing nearly four pounds in paper form, governing virtually every aspect of a company’s financial requirements over the next 12 months.

For Lucent Technologies Inc. (NYSE: LU), that document exists, in the form of an 8-K form filed with the Securities and Exchange Commission last February. At that time, Lucent raised $6.5 billion in revolving credit, which was sold to banks by underwriters Salomon Smith Barney and J.P. Morgan Chase. The government required the company to file the details of that debt agreement in the form of the 8-K.

Four months later, the document is still being heavily scrutinized, and is key to the prognosis of Lucent’s turnaround bid.

So what’s the big deal?

As the document says, “The Credit Facilities are secured by substantially all of Lucent’s assets…”

In other words, in the event of default on the agreement, the banks can lay claim to every piece of Lucent. The 8-K details some complex and strict financial covenants. If these covenants are broken, Lucent would be in default of the debt.

"Many people are worried about these covenants," says one hedge-fund manager, asking to remain unnamed. Recently, the loan covenants have generated a bit of Wall Street discussion — and are likely to have contributed to recent weakness in Lucent’s stock price.

As detailed in the public filing and interpreted by several analysts, some of the key covenants on the debt agreement are as follows:

  • Cash covenant for Agere Systems (NYSE: AGR) spinoff: Lucent must raise $2.5 billion in cash by the end of September in order to spin off the shares of Agere Systems to shareholders (the company has already raised approximately $500 million of that cash). Failing to spin off Agere does not put Lucent in default, but it complicates its outlined recovery plan.

  • Net Worth covenant: Lucent must maintain a net worth (stockholder’s equity, or book value) of $23 billion on the last day of any fiscal quarter, including the value of both Lucent and Agere. At the end of the last quarter, that number stood near $30 billion.

  • EBITDA covenant: Lucent must reach certain targets of EBITDA (earnings before interest, taxes, depreciation, and amortization) in every quarter for the next year, according to a schedule set up by the agreement.

    Among these covenants, the third is most perplexing to analysts, several of whom say they aren’t sure how to calculate the financial figures prescribed in the agreement.
    EBITDA Anyone?

    Most analysts say the requirements for EBITDA — a calculation of a company’s operating earnings minus certain expenses — are the most stringent.

    “The unknown is the scary part,” says Steve Levy, analyst with Lehman Brothers. “The most onerous covenant is the EBITDA requirement. It’s not clear from the 8-K filings how you calculate the EBITDA. We know as we go forward it’s a tougher hurdle to jump over.”

    A Lucent spokeswoman said that analysts should be able to figure out how to calculate EBITDA by reading the definitions in the 8-K document (bedside reading anyone?). So far, Lucent says it is in compliance with all of the covenants.

    Despite the fact that EBITDA is defined in the agreement, some analysts say that variables in Lucent financials make the potential of meeting these requirements difficult to predict.

    On the surface, the schedule itself is telling, because it dictates that a turnaround at Lucent must be fairly swift and predictable. Any further stumble in the telecommunications economy, and the schedule becomes unrealistic.

    Here is the schedule of Lucent’s EBITDA requirements over the next year, as detailed in public filings:

    Time period/minimum EBITDA requirement

  • January 1, 2001 - March 31, 2001 / -$1.525B
  • January 1, 2001 - June 30, 2001 / -$2.35B
  • January 1, 2001 - September 30, 2001 / -$2.35B
  • July 1, 2001 - December 31, 2001 / $335M
  • July 1, 2001 - March 31, 2002 / $775M
  • July 1, 2001 - June 30, 2002 / $1.4B
  • October 1, 2001 - September 30, 2002 / $2.2B
  • January 1, 2002 - December 31, 2002 / $2.6B Nikos Theodosopoulos, analyst with UBS Warburg, discussed the EBITDA covenant in a recent research note: “We note that EBITDA cannot be calculated using Lucent’s financial statements as it excludes certain charges (e.g. vendor financing charges). Thus, we must rely on Lucent indicating whether they met the EBITDA covenant and then generate an estimate.”

    Theodosopoulos, whose note was actually somewhat positive, indicated that he’s not too concerned about Lucent breaking the covenants, because he believes the banks would be flexible and work toward helping Lucent renegotiate them if they are broken.

    "While we do not think Lucent is likely to breach these covenants in the near to intermediate term, it is important to note that the debt governed by these covenants is in the form of bank debt and not public bonds,” wrote Theodosopoulos. “Covenants associated with bank debt are typically easier to renegotiate than those associated with public bond debt."

    The EBITDA covenant dictates that Lucent couldn’t lose more than $1.5 billion on an EBITDA basis in the March fiscal quarter. The company met that amount with a cushion of about $500 million. But the schedule now dictates that Lucent show rapid and sustained improvements in EBITDA over the course of the next few quarters.

    The Spinoff

    There is also the matter of the spinoff of Agere shares, of which Lucent still owns 58 percent. Before the creditors allow that to happen, they are requiring Lucent to raise $2.5 billion in cash to reduce the debt level. The company has been exploring options to meet this covenant, the most common one being a sale of Lucent’s optical fiber division (see Alcatel, Lucent Throw in the Towel and Lucent's $5 Billion Question).

    If Lucent does not raise the necessary cash, it must keep its Agere stock. This does not put Lucent in default of the debt agreement, but it would eliminate one step toward reducing debt in the management’s recovery plan. Also, it would mean that Lucent shareholders would not receive a distribution of Agere shares.

    Lehman’s Levy believes that the company is likely to sell the optical fiber division in the next few weeks, and thus complete the Agere spinoff before the September deadline.

    “My sense is they will sell the fiber business,” says Levy. “You might get a different set of buyers as the price goes down. As the price goes down, the likelihood of selling it goes up. They have to net $2 billion."

    Selling the optical fiber division would put Lucent in a much better financial position by eliminating debt. But several potential deals for the optical fiber division have already fallen through. The price of this business — once thought to be worth $5 billion — appears to be dropping, as the company gets closer to its deadline. Several Wall Street sources believe the deal is imminent and that it should come in the $3 billion range.

    The sale of the fiber division would certainly help restore some confidence in the company's ability to recover — although a sale for less than $3 billion could be seen as disappointing.

    At any rate, the approaching quarterly report, expected next week, will contain more clues as to how well Lucent is negotiating the treacherous course toward recovery outlined by its bankers.

    On Wednesday, Lucent stock dropped 0.28 (4.09%) to 6.56.

    — R. Scott Raynovich, Executive Editor, Light Reading
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