While each vendor financing case varies depending on who's being funded by whom, the service providers requiring vendor financing usually have credit profiles that are weak enough to prevent them from getting all of their funding from other lenders. Also, these service providers typically don't have enough cash to buy the equipment they need to fulfill their business plans.
Cisco, Nortel, and other big equipment vendors won't talk about what conditions their respective vendor financing arrangements include. But carriers confirm that equipment vendors, for starters, usually finance equipment at a lower rate than would a bank.
When it's clear what the service provider needs, it will usually get term sheets that will detail the amount of financing offered, the date of delivery of the equipment, and the conditions at which the vendor will be paid back.
Like a using a Visa card, service providers may have a committed amount of financing from the vendor, like a credit limit, but they don't have to use it. And depending on how the financing is structured, the service provider may have to meet certain business goals before it can draw down on more than half the committed amount.
On the vendor's side, after it finances a sale, the vendor counts the sale as part of its revenues, and the financed equipment shows up as an asset on its balance sheet.
In his report, "The Other Side of Leverage," Lehman Brothers convertibles analyst Ravi Suria writes that vendor financing is a double-edged sword for the vendor, because it could mean a deteriorating balance sheet, and for the service provider, because it aggravates their already weak credit profile.
But vendors often resell their loans to financial institutions, though that's becoming tougher as market conditions have grown gloomy. And, increasingly, vendors arrangements with financial buyers have become more creative. Alcatel, for instance, has an arrangement with Citibank where a trust buys interest in a portfolio of Alcatel's loans to customers.
At a recent meeting with reporters, Nortel CEO John Roth remarked that Nortel has been "very adept at laying [vendor financed debt] off with little impact" on its balance sheet. What's unclear, though, is whether vendors can keep selling loans to banks that have had their fill of telecom debt.
"The clear takeaway from the vendor financing situation is that its important role probably masks the total indebtedness of the services sector when looked at from the viewpoint of primary borrowing," Suria writes.