MRV Communications Inc.'s (Nasdaq: MRVC) plan to spin out its shares of component vendor Luminent Inc. (Nasdaq: LMNE) appears to have run into a bit of a roadblock.

MRV, an optical networking holding company, owns 92 percent of Luminent, a company that went public last year (see Luminent's Dull Debut). MRV has always planned to distribute its Luminent shares to its own shareholders, but current market conditions and MRV's debt are holding up the distribution.

The biggest issue is what MRV is going to do with nearly $90 million worth of convertible bonds, which were issued in 1998 and mature in 2003. In its filings with the Securities and Exchange Commission, MRV has stated that getting rid of its bond debt is one of the criteria for spinning out the shares.

Now, with MRV stock trading well below the bond conversion level of $13 per share, MRV must either buy them back with cash or hope its shares rise to a level at which the bonds would be converted to MRV stock.

A month ago, investors were optimistic that the spinout would happen when the Internal Revenue Service gave MRV the green light to distribute Luminent shares to its shareholders without subjecting them to U.S. federal income taxes (see Tax Man Smiles on MRV Shares). The IRS has given the company until the beginning of November, the anniversary of the Luminent initial public offering, to finish the distribution.

"We will be guided by the most prudent decision for our shareholders,” says Edmund Glazer, vice president of finance and chief financial officer of MRV. “That means that we have to be willing to forgo the distribution if it doesn’t look like it would be good for the shareholders. However, our intention right now is to do the distribution.”

MRV has several choices for handling the situation. For one, it could simply go ahead with the spinout without dealing with the debt. But doing that could have serious repercussions. MRV owns about $480 million worth of Luminent, based on a trading price of $3.34 for 144 million shares of Luminent common stock. Given that MRV’s entire market value is only about $527.4 million, distributing the shares would leave little of tangible value left inside the company. And that scenario is exactly what the bondholders don't want to happen.

“The MRV stock is barely worth more than its stake in Luminent,” says one bondholder, who didn’t want his name used. “If this were a big company it wouldn’t matter, but they are essentially stripping MRV of its worth. It’s fraudulent and a real nasty thing to do your bondholders. We aren’t afraid to sue them if we have to.”

Glazer says the company has no intention of leaving bondholders in the lurch. “I can’t imagine that we would simply go ahead with a transaction that would be unattractive to our bondholders and shareholders,” he says. “We would like to see some way of seeing the notes converted before distribution.”

As of last Friday, June 15, the company was still able to call in the bonds, which means that the bondholders would have thirty days to decide whether they want to convert the bonds to MRV shares or take the payment as cash.

In its last quarterly filing, MRV reported it has about $190 million in cash. Buying back the bonds would cost them $90 million, which means it is better for the company if the bondholders convert the bonds to shares of stock even though it will dilute shareholder equity. But with the conversion price of the bonds set at about $13 and MRV trading at roughly $7, bondholders have little reason to convert instead of taking the cash, say analysts.

All hope is not lost, though. MRV can still offer bondholders an incentive to sweeten the deal. Most likely this would come in the form of additional shares or a refinancing of the 5 percent interest rate on the bonds.

“They can’t make us do anything,” says the bondholder. “But I think they really want us to convert, so they will probably try an incentivized conversion. The funny thing is they could have offered a deal when the bonds were trading at 500 cents on the dollar. We probably would have taken it. But they were greedy.”

Even though bondholders are concerned about recouping their money, they are also using the situation to their advantage. One bondholder admits that his firm has been short-selling the MRV stock, which has given him a better negotiating position by keeping the stock lower.

The situation has changed drastically over the last eight months, since Luminent first went public (see Investors Head for Luminent's Back Door). Back in November, investors were buying shares of MRV in anticipation of getting Luminent shares for free. But MRV’s stock has fallen from around $28 a share to about $7 a share, putting the whole plan in jeopardy.

When and if MRV spins out Luminent, one big question lingers: What next? MRV is a holding company, which means that its only real value to investors is the companies in its portfolio.

Some of MRV’s other holdings include, iTouch Communications, Optical Access Inc., NBase-Xyplex, Zaffire Inc., Zuma Networks Inc., and Charlotte’s Networks Ltd.. So far, Luminent is the only one that is publicly traded and producing significant revenue. Even though Optical Access is in registration for an IPO with the SEC, it’s clear that none of the MRV companies is going public anytime soon.

“The conditions now are terrible for a model like ours,” says Shlomo Margalit, the chairman of the board for MRV. “You really have to have chutzpah to take a company public right now.”

Some analysts say that MRV is actively shopping around some of its holdings to bulk up its cash reserve. Zaffire is one of the most likely candidates for a sale, even though MRV has only a 20 percent stake in the company.

- Marguerite Reardon, Senior Editor, Light Reading
http://www.lightreading.com