In yesterday’s Wall St Journal article about lenders “turning up the heat” on Phil Falcone (which surprisingly failed to mention whether he is sweating or not) it was intriguing to note that the article was changed during the day by the removal of one critical sentence. Specifically the version of the article as it was original published on Friday morning and then updated on Friday afternoon (at 3.28pm ET) contained the following paragraph:
The lenders believe Mr. Falcone has become a lightning rod that has made dealing with Washington regulators too difficult and threatens to upend the company’s chances of success, the people said. The lenders believe there are signals coming from Washington that show a willingness to engage in dialogue over LightSquared’s woes, but that Mr. Falcone’s presence could impede progress, one of the people said.
However, in the final version of the article (from 6.41pm ET and as published in today’s paper), this paragraph was simplified to:
LightSquared needs the regulators’ blessing for its nationwide mobile broadband network to succeed. The lenders believe Mr. Falcone has become a lightning rod who has made dealing with regulators more difficult, the people said.
This change might be taken to imply that there is some sensitivity on the part of the first lien lenders to even the vaguest hint that their billions of dollars could now succeed in securing a spectrum swap, when Falcone no longer has the billions to achieve that goal. After all, as I noted back in January 2011 and has been clear from the number of lobbyists hired by the company, LightSquared certainly felt that it was necessary to throw a great deal of money around in order to gain approval for its network.
One of the counter arguments coming from Harbinger is that “they doubt Icahn will get better results from DC” especially if (as Falcone claims) the debtholders are only interested in a “quick flip”. More importantly, I suspect that (as the change in the WSJ article suggests) after all that has happened in the last year, the FCC, White House and Congress will all now be extremely sensitive to any inference that money can buy LightSquared some love in DC, whether we have a Democratic or Republican administration after the election in November.
UPDATE (4/30): Last night the WSJ reported that Falcone has agreed to step aside “eventually” in exchange for a one week extension of the waiver of LightSquared’s debt covenant violations. This will allow negotiations on an extension of the waiver for 18-24 months, conditional on Harbinger agreeing to substantial dilution of its equity stake. The WSJ article suggests that debtholders do not want LightSquared to file for bankruptcy, because that would potentially allow Harbinger to maintain control.
However, it seems that the more plausible concerns relate to the assumption by both sides that any spectrum swap would come relatively soon after the November presidential election, and so by tying up the company in bankruptcy, Harbinger could preserve the chance of a recovery for its equity for much longer. This would be similar to DBSD, which originally planned to hand over the company to its second lien debtholders when it filed for bankruptcy in May 2009, but after a very prolonged stay in bankruptcy (due to Sprint and DISH’s appeals of the reorganization plan), eventually sold the assets to DISH in an auction in early 2011, paying off the second lien debt at par and providing a recovery for the equity holders (ICO Global).
We therefore still have to see if Falcone will be prepared during this week’s negotiations to countenance an immediate substantial dilution of Harbinger’s equity as a condition for avoiding bankruptcy. Clearly such an action would lock in a significant loss to Harbinger, as opposed to preserving all of the equity upside in a bankruptcy situation. Conversely, a bankruptcy filing would run the risk of Harbinger losing everything, if the debtholders can persuade the judge that the assets available simply do not justify contemplating a recovery for LightSquared’s equity holders. As a result, at the end of this week there could well be a significant gap between the equity dilution Harbinger would accept (perhaps less than 50%?) and that demanded by the debtholders (80%+?). In those circumstances, a bankruptcy filing and valuation fight might be the only remaining option for both sides.
The news this morning that LightSquared has made the $56.25M payment to Inmarsat that was due in February and in exchange gained two years “breathing space” before any additional payments need to be made, is in line with the deal that I noted was on the table two weeks ago, and shows that Harbinger is still attaching importance to its spectrum rights under the agreement with Inmarsat as it tries to argue for a “spectrum swap”. In a way the $56.25M paid today may not be that important in the end, because if LightSquared files for bankruptcy within the next 90 days then that amount could probably be reclaimed by LightSquared’s creditors.
However, far more significant is that LightSquared has also given up all claims that Inmarsat had failed to perform its obligations under Phase 1 of the Cooperation Agreement (despite the fact that Inmarsat failed to retrofit any of its terminals with filters) and as a result Inmarsat is now saying there is “a high degree of confidence” that it will be able to recognize a further $325M. I’m informed that LightSquared had told its investors that there was “no good basis” to challenge Inmarsat’s assertion that it wasn’t actually necessary to fit filters, and it certainly appears that Inmarsat now has no intention of doing so, and instead will simply be able to recognize a further $325M (on top of the $154M recognized to date) out of the $490M paid by LightSquared up until the end of 2011 as pure profit.
Why did LightSquared make this payment, rather than filing for bankruptcy and preserving its right to sue Inmarsat for part of the money back? One explanation certainly appears to be Falcone’s continued delusional view that LightSquared’s problems can be overcome, and this fits right in with the decision back in December to give up $236M to Sprint in exchange for preserving their hosting agreement for a further three months.
More intriguing is whether this development could signal an agreement with Carl Icahn is going to be reached before April 30, which would keep LightSquared out of bankruptcy, as Falcone apparently desires, perhaps in exchange for Harbinger selling its Ferrous Resources shares to Icahn at what seems to be quite a low price. On the other hand, Falcone might simply be trying once again to convince LightSquared’s investors that he is the only person who can strike the deals necessary to keep LightSquared alive, and its also worth noting that Harbinger still needs to raise $47M from the sale of assets by April 30, regardless of whether a deal is reached over LightSquared (so that the Ferrous Resources sale has to happen anyway).
What this may therefore point to is a finely balanced situation where it remains unclear whether Icahn and his allies have sufficient votes to call a default on LightSquared’s debt after April 30. In particular it is not clear whether they would need to secure 50% support to call this default or as much as a two-thirds majority, which could be far more difficult. Today’s actions may or may not persuade some debtholders to support Falcone rather than Icahn, but as we saw with the Sprint deal, the potential recovery for LightSquared’s investors in the absence of a spectrum swap is rapidly vanishing, with only the ground spare satellite providing any reasonably monetizable asset, and a major part of the ($200M?) cash on LightSquared’s balance sheet will ultimately be consumed by bankruptcy costs.
Its therefore particularly hard to understand why the LightSquared debt has been consistently trading higher, to as much as 53-55 cents on the dollar this morning. The only way to rationalize the rising price of the LightSquared debt is that other investors think that because someone as smart as Icahn is getting involved, there must be a good opportunity here. However, as we saw a decade ago with Craig McCaw’s interest in Iridium and ICO, which ultimately resulted in him taking a huge loss, the satellite industry has a history of disappointing smart investors. With Andy Beal knowing only too well this industry’s cycle of “hopeful and ambitious birth, thrilling and painful growth, and an early and tragic death”, maybe he’s really the smart one to get out at this point. After all, as the Dallas Observer’s epitaph for Beal Aerospace pointed out: “I guess it’s hard to be a genius”.
UPDATE (4/23): LightSquared’s debt has traded even higher, as investors apparently believ a near term bankruptcy is becoming less likely. It seems like a consensus is emerging that Icahn will not have the votes to force a bankruptcy at the end of the month, and so a relatively lengthy extension may well be granted on the breach of covenant waiver, potentially through the end of this year. Even after making the payment to Inmarsat on Friday, LightSquared should have enough money to make its cash interest payments in July and October (totaling ~$50M), cover the operating costs of the current business and still have perhaps $50M-$100M of cash left at the end of 2012. I also understand that LightSquared has asserted that a spectrum swap should be forthcoming after the November 2012 election, although their recent track record of predicting favorable FCC actions is hardly encouraging for investors. However, as noted above, in the absence of a spectrum swap, the potential recovery for investors at that point will be even less, and it will be interesting to see whether Boeing still wants to buy the ground spare satellite next year, given that construction of the MEXSAT-2 satellite for the Mexican government will start relatively soon (the MEXSAT-1 satellite is scheduled for launch in 2013 or 2014).
UPDATE (4/27): The Wall St Journal is reporting today that LightSquared’s lenders are insisting that Falcone step aside as a condition for agreeing not to call a default on Monday. It appears a deal might be possible to keep the company out of bankruptcy for a substantial period of time, perhaps by substantially diluting Falcone’s equity stake, and thereby avoiding the complications (e.g. FCC license transfers) and expense that would be involved in a bankruptcy case. However, it is far from clear that Falcone will do the logical thing and step aside at this point. After all, when I’ve been wrong in my predictions about how things will go, its usually because I’ve assumed that Falcone and LightSquared will act rationally in the interests of their investors.
This week’s Bloomberg article about LightSquared had an interesting assertion from Nathan Pettit, an assistant professor at New York University’s Stern School of Business that “Falcone’s doubling down on LightSquared fits a pattern”:
“People of status and power have an illusory sense they can control more than they do,” said Pettit. “That leads to unrealistic optimism, increased risk-taking and decreased inhibitions.”
That brought back memories of the classic case study on Iridium’s 1999 bankruptcy, by Sydney Finkelstein, which was included in his book “Why Smart Executives Fail” (uniquely, Motorola actually features twice in the book, both for Iridium and for missing the transition to digital cellphones). I wonder if Mr. Falcone has ever read this book and case study, because the parallels with the LightSquared debacle are quite striking. In particular, the three forces that according to Finkelstein combined to create Iridium’s business failure were:
1. Escalating commitment among Motorola executives who pushed the project forward in spite of known and potentially fatal technology and market problems
2. For personal and professional reasons Iridium’s CEO was unwilling to cut losses and abandon the project
3. Iridium’s board was structured in a way that prevented it from performing its role of corporate governance
In the case of LightSquared/SkyTerra/Harbinger, it is pretty easy to identify exactly the same problems:
1. Escalating commitment by Falcone, who kept devoting an increasing proportion of Harbinger’s assets to SkyTerra/LightSquared (and other spectrum projects such as TerreStar), despite Falcone’s apparent awareness of the GPS interference problems and the lack of interest from wireless operators in buying this (or any other MSS) spectrum. Similar to Motorola, Falcone’s history was that similar bets (e.g. in subprime mortgages and iron ore) had paid off in the past and so just as with Motorola he has maintained his “arrogance” that “the investment thesis was dead-on“.
2. Unwillingness to cut losses, because Harbinger’s investment was in equity, which would all be wiped out if Falcone did not continue with the project, but the chance of a recovery could be preserved by raising additional senior debt from third parties (just as with Iridium, where the bondholders also got stuck with a 99% loss because in the end the assets were essentially worthless).
3. Lack of corporate governance, because Falcone was able to make whatever bets he wanted with Harbinger’s money, despite the fact that as another Bloomberg interviewee pointed out “There should have been constraints on risk and concentration of the investments”. In addition, SkyTerra’s board was focused solely on trying to raise money and then sell the company to someone else (Falcone) rather on whether they actually had a viable business at the end of the day, because they could never hope to fund a terrestrial network buildout themselves.
As I’ve pointed out before, it took nearly nine months after the Iridium bankruptcy filing in August 1999, before the investors actually realized that the assets were worthless (and considered de-orbiting the satellites), during which time even as smart an investor as Craig McCaw considered a multi-billion dollar commitment to rescue Iridium. Indeed in the end McCaw and others actually committed $1B+ to rescue the similar ICO project, much of which now looks to have been wasted after ICO’s jury verdict against Boeing was reversed last week. As we look to what will happen next, I’m therefore left wondering if history will once again repeat itself, with Icahn in the role of McCaw, and a decade long court case in the offing.
Separate articles published yesterday by The Daily Beast and Bloomberg had plenty to say about Phil Falcone’s “deep perspiration stains” and his claim that “he doesn’t sweat” under pressure. However, with the waiver of the covenant breaches on LightSquared’s first lien debt expiring on April 30, the heat is certainly on him to figure out the way forward.
Bloomberg’s article indicates that Falcone is hoping Carl Icahn “might become a partner”, as he searches for a way to keep LightSquared out of bankruptcy. In that context it is interesting to note that news emerged last week that Icahn is nearing a deal to buy a 14.9% stake in Ferrous Resources, a Brazilian iron ore mining company, from Harbinger at a price of $1.50 per share, one third of what Harbinger paid for shares in the company in 2009 and less than half of the valuation put on these shares by Harbinger in January 2012. At least conceivably, such a deal could provide a quid pro quo for Icahn’s support in keeping LightSquared out of bankruptcy, and it is notable that Harbinger also needs to raise $47.5M from this asset sale to repay its own loan (from Jefferies) by April 30, the same day that the LightSquared covenant waiver expires.
Two weeks ago I thought that the April 20 deadline (this coming Friday), when Inmarsat can terminate its Cooperation Agreement with LightSquared, could provide the impetus for a decision on whether or not to file for bankruptcy sometime this week. However, if the future of Harbinger itself is riding on avoiding a potential default on the Jefferies loan, then the Inmarsat deadline might well now be ignored. Inmarsat has been standing firm on its insistence that it must be paid even more money to contemplate any extension of the Cooperation Agreement, so if the April 20 deadline passes without payment being made, then it is hard to see an outcome where Inmarsat doesn’t just terminate the Agreement for default, and reclaim several additional MHz of spectrum from LightSquared as part of these default conditions. In those circumstances, it would become even harder for LightSquared’s successors to ever deploy a terrestrial network in the L-band MSS spectrum, even if the FCC was to mandate GPS receiver standards at some point in the future.
As a result, we may soon be asking what is actually left for LightSquared’s creditors, in the absence of any agreement with Inmarsat or Sprint, other than a ground spare satellite (which at least originally was worth $120M to Boeing, based on their vendor financing agreement) and an in-orbit satellite (which is probably worth very little, given its negative cashflows). Of course, LightSquared will try and sue the government, but that may now be made much harder by the statements of DirecTV’s CEO, who told Bloomberg that they “looked at LightSquared’s spectrum in 2004″ and concluded “It conflicts with GPS, it will never work”. DirecTV’s CEO may be misremembering the events, because Rupert Murdoch (then owner of DirecTV) was telling the Wall St Journal in November 2005 that “We may be forming a company with partners to build something out here that would give you broadband” and I had understood that these discussions were in 2005 (possibly even into early 2006) and broke down mainly over price.
Nevertheless, even Falcone admitted that in 2010 he “knew there were interference issues [but] they weren’t his to solve because GPS users were encroaching on his spectrum”. If that is the case then wouldn’t it have been rather better to tell the GPS community about the problem years ago, rather than try to spring it on them as a fait accompli at the last minute? It seems that as DirecTV’s CEO put it “Falcone ‘made a bet that the government would say, “Sure, go ahead,” or somehow make it right.’”.
Of course the complaints of Harbinger’s own investors will be significantly boosted by Falcone’s admission, and LightSquared’s investors may well suggest that UBS ought to have enquired more deeply into this issue before selling the first lien debt. However, for the moment, both Falcone and LightSquared’s debt investors appear to be more focused on securing a spectrum swap, which as Walt Piecyk says in the Bloomberg article (and as I’ve said many times before) “isn’t a realistic option [because] there’s nothing readily available and…if there was, that’s spectrum that could be auctioned off for billions in proceeds”.
Indeed the news today that the FCC has appointed Gary Epstein, a former SkyTerra executive, as co-head of the Incentive Auction Task Force (something which has already attracted Sen. Grassley’s attention) may make it even harder for the FCC to take any action to help LightSquared, because further accusations of favoritism would be sure to follow.
“Every two and a half years, every spectrum crisis has gotten solved, and that’s going to keep happening,” Mr. Cooper said. “We already know today what the solutions are for the next 50 years.”
In fact, the CTIA’s semi-annual statistics, released last week, gave a pretty clear indication of what those solutions are. Remarkably, in the last six months of 2011, an all-time record 26,465 cell sites were added in the US (an increase of more than 10% in just 6 months) despite the fact that wireless capital investment by the carriers during 2011 was up only 1.7% on 2010. Thus it seems pretty clear that deployment of new (small, lower cost?) cell sites for capacity enhancement is working very well to accommodate increasing amounts of data traffic, without imposing any significant burden on the wireless operators. Indeed, with the operators apparently able to include on-net WiFi traffic in the data they report to CTIA, as AT&T is probably doing, the need for more licensed spectrum may be reduced even further. As a result, if LightSquared’s investors ever believed Mr. Falcone’s assertion that “it is clear that the investment thesis was dead-on” then maybe they ought to start having some doubts about that as well.
Mr. Falcone has responded by suggesting that he is “seriously considering” a “voluntary bankruptcy” as “one of several options” for the company. More pointedly, yesterday he indicated (in a very explicit reference to Icahn) that this would be an attempt to “protect the company from creditors who are more interested in a quick flip”.
Of course, the idea that Harbinger could remain in control rests on Falcone’s view that “a bankruptcy would not necessarily wipe out the equity holders of LightSquared because the spectrum it owns retains value” (something that I’m told debtholders consider simply “delusional”). At this point in time, the LightSquared spectrum is only usable for satellite services, which its very hard to believe could generate any positive value (because it would be difficult and time consuming for the satellite business even to reach cash flow breakeven).
As I’ve said in the past, the best case is that 20MHz of the spectrum might be usable in a decade or more for a terrestrial service, but if you have to wait a decade for the spectrum to be usable, and LightSquared’s “$10B waiver” has been withdrawn, then its hard to see why anyone would pay more than the $1.4B DISH paid for 20MHz of TerreStar spectrum last summer. Unfortunately using the spectrum at all would require maintaining the lease deal with Inmarsat at an NPV cost of somewhere between $1.5B and $2B (depending on the discount rate applied), which would need to be deducted from the above sum, and so its not clear that there is any positive value for the spectrum under this scenario either.
The last remaining hope to have some usable (and valuable) spectrum in the near term is to engineer a spectrum swap, but that would rely on the DoD showing some goodwill towards LightSquared, something which has hardly been evident to date.
As a result, after a voluntary bankruptcy filing, we would be thrown headlong into a valuation fight, where the debtholders tried to argue to the judge that LightSquared’s likely attribution to itself of a $2B-$3B valuation and proposed cramdown of the first lien debt was simply not feasible. It is difficult to see LightSquared prevailing, when the basis for a high valuation of the spectrum is simply not sustainable. However, these arguments will tie the company up in court for the rest of the year, and in the interim presumably Harbinger would try to stay in charge.
The timing of a bankruptcy filing is likely to be dictated not only by the April 30 expiry of LightSquared’s waiver in respect of the covenant breach from the termination of the Sprint agreement, but also by the status of LightSquared’s Cooperation Agreement with Inmarsat. Earlier this week, a deal appeared to be on the table whereby LightSquared would make the missed February payment of $56M and give up any claims that Inmarsat had failed to complete Phase 1, in exchange for a two year deferral of further payments. However, LightSquared appears reluctant to pay out additional money to Inmarsat when a bankruptcy filing would also prevent Inmarsat from terminating the Cooperation Agreement and could still allow LightSquared to reach a resolution with Inmarsat later on if that was felt to be useful. As a result, I expect LightSquared’s bankruptcy filing to come before the April 20 deadline on which Inmarsat can terminate the Cooperation Agreement for default, and plausibly it could be made over the weekend of April 14/15.
Mr. Falcone has also taken to the press to accuse “the FCC of bowing to special interests” by blocking his “shovel ready” project. The article suggests that he “first got into the telecom business in 2010″ when he “placed a $14 billion bet on what he thought was a sure thing”, which of course is revisionist history at its worst. In fact Mr. Falcone had been an investor in the predecessors to LightSquared and TerreStar since 2004, and made most of his purported $2.9B investment well before 2010.
Since the FCC granted the SkyTerra transfer of control (including various ATC license modifications and what appears to have been an implicit promise of a later waiver) to Harbinger in March 2010, the investment has mostly come from third parties. By my calculations, Harbinger has only invested about $700M into LightSquared over the last two years (including the cost of buying out minority equity investors in SkyTerra), while other investors have put in roughly $2B.
A better account of the history would be that by late 2009 (when Harbinger decided to buy out the other investors in SkyTerra), Harbinger had already invested over $2B in this project which had all gone to waste. At that point, Mr. Falcone desperately tried to rescue his losing bet (with assistance from the FCC) by persuading other people to invest their money into this supposedly valuable spectrum.
Remember that Harbinger also invested almost $1B in TerreStar’s equity and preferred shares from 2005 through 2010, attempting the same trick of converting satellite spectrum for terrestrial services, and that also was lost when Echostar acquired TerreStar’s senior debt and pushed Harbinger out, just as Icahn is likely to do in LightSquared. Ironically, back in August 2010, when TerreStar was on the point of bankruptcy, Falcone also claimed to Reuters that TerreStar’s senior debt was easily covered by its spectrum value. He was wrong then, as DISH’s ultimate bid was just enough to pay off the senior debt (which Echostar held the majority of) at par and unsecured creditors lost most of their claims (while the equity in TerreStar Networks was worthless). In the case of LightSquared it appears he will be wrong by an even greater margin, because GPS interference and the Inmarsat lease costs will dramatically reduce any interest in buying the LightSquared spectrum, and make it hard even for secured creditors to realize much of a recovery.
Today news has emerged that Harbinger posted a near 30% decline in its flagship fund in February, due to a writedown of the value of its LightSquared equity investment by “outside auditors”. This comes on top of writedown of its LightSquared investment late last year, which led to the fund declining 47% in 2011, after a 59% cut in the value of its LightSquared holdings.
At the end of January 2012, Harbinger reportedly valued LightSquared’s equity at $1.5B, implying that prior to the 2011 markdown it was valued at ~$3.65B, for a total LightSquared enterprise value of perhaps $6B, given the amount of additional funds that had been raised. The new valuation being put on LightSquared’s equity is not stated, but can be deduced from the fact that in January Harbinger’s largest fund reportedly had total assets of $2.4B, of which $1.07B was LightSquared debt and equity. If the LightSquared equity component was ~$1B, then a ~30% writedown in the fund’s overall value could equate to as much as a 70%-75% writedown in the value of LightSquared’s equity. In other words, LightSquared’s equity may now be valued at less than $500M by Harbinger’s outside auditors.
While this valuation may soon be irrelevant once LightSquared files for bankruptcy, one interesting side effect is that the cut in the value of Harbinger’s fund appears to make it very likely that Mr. Falcone is no longer a billionaire, as was indicated by Forbes just a few weeks ago. The Forbes calculation came just prior to the February writedown, and given that Mr. Falcone’s wealth moves very much in line with the value of Harbinger’s fund (because as he told Vanity Fair last summer “I have always kept the bulk of my money, and I mean the bulk of my money, in the fund”), the 30% writedown seems all but certain to have cost Mr. Falcone more than $100M of the $1.1B that Forbes calculated he was worth last month.
This week it was quite astonishing to see a Wall St Journal article hyping the in-flight passenger communications market in advance of Gogo’s planned IPO on NASDAQ, by highlighting incorrect statistics from In-Stat about the size of the opportunity. In particular the WSJ article states:
Currently about 8% of passengers use the service, up from 4% at the end of 2010, according to In-Stat, a research and consulting firm. That likely will reach 10% of passengers by the end of this year, In-Stat says.
Gogo’s amended S-1, filed on Wednesday, gives specific data for the take-rate on Gogo-equipped planes (nearly 90% of the market in the US), noting that it remained constant at 4.7% in both 2010 and 2011. Underlying usage is increasing, but the usage figures were distorted in late 2010 by a large sponsorship from Google (around $7M) which offered free access for 6 weeks between Thanksgiving and New Year. I’ve tried to back out the estimated quarterly evolution of Gogo’s revenues and take rate over the last three years, and as shown in the diagram below, the take rate at the end of 2011 was only just over 5%, and on current trends it will take several years to reach the 8% that In-Stat is wrongly suggesting is the take rate at present, let alone the 10% take rate In-Stat projects for the end of 2012.
Of course In-Stat’s projections of the in-flight communications market have been miles off all along. Last October, In-Stat claimed that “in-flight Wi-Fi revenue is expected to grow from about $225 million in 2011 to over $1.5 billion in 2015″. In reality, Gogo’s in-flight passenger WiFi revenues were just over $80M in 2011 and total passenger spending on in-flight connectivity services worldwide was only about $100M last year (most international services are supported by Inmarsat, who said on their recent results call that passenger connectivity generated between $2M and $3M of wholesale revenues in 2011). Surprisingly, Gogo even quotes an In-Stat forecast in its S-1 stating that “in-flight internet usage is expected to increase rapidly over the next five years, from approximately 15.6 million North American sessions in 2011 to 96.9 million by 2015″. However, with Gogo having only had 9M sessions in 2011, it is inconceivable that there could have been more than ~10M sessions in North America last year.
In this context, it is very surprising that the WSJ decided to quote In-Stat’s data without verifying it against the information in Gogo’s public filings. It is also worrying, with Gogo’s IPO set to take place in the near future, if potential investors take the WSJ article at face value and have a misleading impression about the current state of the in-flight communications market.
Bizarrely enough, the price of LightSquared’s debt has been increasing over the last week, as the company failed to file for bankruptcy in advance of the termination of their agreement with Sprint, which is expected to come today, and LightSquared hired lawyers to sue the government for compensation, once their ATC license is revoked by the FCC. The primary reason for this delay appears to be that major investors (Icahn/Appaloosa/Beal, who may hold as much as $500M-$600M in face value of the $1.6B in first lien debt) are sitting on the sidelines, apparently unable to decide what they would do if they forced LightSquared into bankruptcy, while UBS (who may still hold $300M-$400M of the first lien debt) certainly do not want a bankruptcy (because then they would probably become a target for litigation).
As I understand it, if LightSquared continue to pay the interest on their debt (of which ~$50M in cash is due on April 1) then a two-thirds vote of debtholders would be needed to force the company into bankruptcy, and so I now expect that LightSquared will probably make the interest payment due at the end of this month. Once Sprint return $65M to LightSquared after their agreement is terminated, and with payments no longer being made to Inmarsat, LightSquared will then still have over $200M in cash on its balance sheet at the end of the first quarter, allowing LightSquared to continue to pretend (for potentially the rest of this year) that they can succeed with a lawsuit against the FCC or obtain a spectrum swap from the government. The only large near term outstanding payment is the repayment of around $300M due at the end of June on LightSquared’s holding company loan, and LightSquared are suggesting that the sale of their terrestrial spectrum leases will be enough to cover this repayment (though that assumes both a favorable proposal from the FCC next week and a lot of interest in the 1670-75MHz spectrum).
Of course if LightSquared do drag this situation out for so long, then the potential recovery for investors may be considerably less than I originally anticipated. LightSquared appears unlikely to challenge the termination of its deal with Sprint, thereby writing off $236M that was advanced to Sprint last year, and may also allow its deal with Inmarsat to expire on April 20, thereby preventing any deployment of a terrestrial network in their L-band spectrum in the future and potentially giving up the $490M paid to Inmarsat so far. In addition, there may be little or no cash left on the balance sheet, limiting any recovery and perhaps even raising the possibility of DIP financing being needed for a lengthy bankruptcy. Thus its hard to see why investors would regard a delay in a bankruptcy filing as a positive development for the company.
In the meantime, LightSquared also continues to have bad luck with its satellite, after the new SkyTerra-1 satellite suffered a lengthy outage last week, leaving its existing satellite customers (over 200K terminals) without service from March 7 to March 11. While the satellite does not appear to be damaged, this event will undoubtedly be exploited to raise further doubts about whether customers could rely on the LightSquared satellite for service, assuming the second satellite remains a ground spare rather than being launched into orbit.
This development may also make it harder to come up with an alternative satellite-only business plan to preserve the LightSquared business while the FCC considers whether to allow terrestrial use in the L-band at some point in the distant future, after a lengthy transition period to allow GPS and MSS terminals to be upgraded.
However, it was already difficult to envisage such an outcome, when the majority of panelists on the spectrum panel I moderated this week at the Satellite 2012/MSUA-9 conference estimated that it would take 15-30 years before any terrestrial network could be deployed in the L-band MSS spectrum, beyond the end of life of the SkyTerra-1 satellite.
After the FCC’s release yesterday evening of the agenda for the March 22 Commission Meeting, we are soon going to find out if DISH has struck a deal with the FCC to secure a waiver of the ATC restrictions in the 2GHz MSS band. Some commentators have seen the FCC agenda as a negative sign, pointing to potential delays in DISH’s deployment, based on the comments made by Charlie Ergen last week.
However, another way to look at this announcement is that the FCC is simply moving to implement the provisions in the spectrum bill signed by the President last week (including the proposal for “an alternative band plan…at 1695-1710 MHz”), which as I pointed out, clearly indicates that DISH would potentially give up 10MHz of spectrum and move its uplink band up by 5MHz to enable use of the PCS H-block.
Assuming that DISH gives up half of its uplink spectrum and this is converted into an additional 10MHz unpaired downlink at 2000-2010MHz (with an implicit guardband at 2010-15MHz), thereby maximizing the value of spectrum to be included in a future auction (and allowing Sprint the possibility of a 10x20MHz LTE Advanced network), then a rulemaking would certainly be needed to develop service rules for this new band configuration. However, it seems unlikely that the FCC would want to go back on what appears to have been a carefully engineered compromise passed by Congress just a couple of weeks ago. Given that Sprint’s agreement to settle its litigation against DISH back in October was also likely founded on a desire to gain access to the H-block spectrum, it wouldn’t just be DISH that would be upset by such a decision.
The proposed rulemaking may also achieve a couple of other purposes for the FCC. First of all it allows any deployment timetable to be keyed off the point when the new rules become final, thereby solving the arguments over whether the clock should start running on DISH’s buildout now or in 2015. Secondly it may help to push any bid by AT&T to buy DISH out beyond the November 2012 election and provide time for DISH to pull together an alternative consortium of partners (which might include one or more of T-Mobile, MetroPCS, DirecTV and America Movil). The wholesale access conditions contemplated by the Commission could then ensure that AT&T would not be able to unwind other partners’ access to this network in the future.
UPDATE (3/2): The FCC has just approved the transfer of control for DBSD and TerreStar this evening, but denied DISH’s application for the waiver, deferring this issue to the NPRM which will be considered at the Commission meeting on March 22. It appears that the FCC still wants to pursue the path outlined above, but was worried about the ramifications of granting the waiver without consideration of the proposed deal in a full public rulemaking, especially in the context of impending litigation from LightSquared. This also should allow the Commission to push any prospective bid from AT&T for DISH beyond the November 2012 election. However, with DISH noting in their results call that a refusal to grant the waiver could cause them to significantly change their plans, it will be very interesting to hear DISH’s reaction and see whether they will take this proposed deal off the table (for example by returning to the dual mode handset model contemplated by the original ATC rules), thereby torpedoing the FCC’s chances identifying 15MHz of additional spectrum to auction as Congress mandated last month.
FURTHER UPDATE (3/2): It sounds like the FCC is doing its best to reassure DISH that the outcome of the rulemaking is going to result in the band being redesignated for terrestrial-only services, and that a ruling will come before the end of the year. DISH’s response (with its reference to delaying “the advancement of some of President Obama’s and the FCC’s highest priorities”) appears to hint at the real reason for this delay, that after the LightSquared debacle, the White House simply doesn’t want any more trouble before the November 2012 election, and certainly doesn’t want to contend with an AT&T takeover bid for DISH in that timeframe.
According to this book, Americans are “the worst negotiators on Earth” and it appears that LightSquared are unlikely to prove the author wrong. I noted last week that LightSquared’s contract with Inmarsat apparently permitted Inmarsat to assert completion of its Phase 1 spectrum transition (under which it is paid $250M to fit filters to its terminals) without actually retrofitting any terminals. Specifically the Cooperation Agreement with Inmarsat signed in Dec 2007 states that:
In accordance with the provisions of this Agreement, each Party shall expedite the development of an implementation plan, which shall be coordinated with each of the other Parties, that will reflect all such actions as shall be necessary or advisable to effect the implementation of the L-band frequency ITU Region 2 use arrangements set forth in the respective Spectrum Plan, including, but not limited to (i) replacement or modification of user terminals, including in the case of the Phase 1 and Phase 2 Spectrum Plans, adding appropriate filters to all terminals operating on the Inmarsat system that might otherwise receive interference from or cause interference to the operation of the systems of the MSV Parties operating in accordance with this Agreement (or otherwise addressing such interference by other appropriate means, including at the absolute discretion of Inmarsat by discontinuance or replacement of any affected service or terminal)…
While at first sight it would appear that this clause requires Inmarsat to actually fit some filters, I believe that Inmarsat will argue they are given “absolute discretion” to simply replace any terminal that is affected by LightSquared’s operations, using the new filter technology it has developed, and of course no terminals will be affected if LightSquared never operate a terrestrial network.
In addition, Section 4.4 Payment on Completion of Implementation of Phase 1 Transition states:
The MSV Parties shall not be entitled to operate under the Phase 2 Spectrum Plan or benefit from the operational parameters set forth in Section 3.5 [ATC Operations] until such time as the payment under this Section 4.4 is made to Inmarsat.
Thus if LightSquared do not make the $56.25M payment that they skipped on February 18, they are not allowed under the terms of the Cooperation Agreement to actually operate a terrestrial (ATC) network. Of course its not only LightSquared’s agreement with Inmarsat that is a bad sign for potential investor recoveries after the inevitable bankruptcy filing, but also the status of its agreement with Sprint, as revealed today in Sprint’s 10-K for 2011, which states:
The arrangement contains contingencies related to possible interference issues with LightSquared’s spectrum, including the right of Sprint to terminate the arrangement if certain conditions are not met by LightSquared. As of December 31, 2011, the Company had received $310 million of advanced payments from LightSquared for future services to be performed under the spectrum hosting agreement.
Beginning in December 2011, through a series of amendments, the arrangement was modified to, among other things, extend the date in which Sprint has the right to terminate the arrangement and suspend Sprint’s obligation to incur any further cost or expense related to performance under the original agreement. Under the amended arrangement, Sprint, for any reason, including but not limited to FCC action or inaction, or no reason at all, may terminate the agreement after March 15, 2012 and before April 30, 2012. If LightSquared secures lender’s consent for modifications to the agreement, Sprint’s right to terminate will be deferred until June 25, 2012 and will continue through December 31, 2012. In addition, the parties definitively agreed that approximately $236 million of the total $310 million of advanced payments made by LightSquared represent payment for incremental costs or obligations incurred by Sprint under the original agreement in support of LightSquared. The parties agreed that this amount is irrevocably and unconditionally paid and will not be subject to dispute or claim by LightSquared. Accordingly, Sprint will refund up to approximately $74 million of Lightsquared’s initial prepayments, of which $65 million will be paid on the earlier of LightSquared’s lender’s consent or March 15, 2012, and the remaining $9 million will remain subject to the termination and unwind provisions of the original agreement and will be returned to LightSquared upon termination, less any additional incremental cost or obligations incurred by Sprint in support of LightSquared. In the event the arrangement is terminated for LightSquared’s material breach, non-payment or insolvency, Sprint maintains a second lien on certain of LightSquared’s assets, including spectrum assets.
Thus in December 2011, LightSquared definitively agreed to forfeit $236M of its advance payments to Sprint if they were unable to move forward which the agreement, which seems a huge sum of money when it appears Sprint had done basically nothing in terms of deployment apart from some initial network planning. Clearly LightSquared were deluding themselves as well as investors in December when they insisted that approval was going to be forthcoming in early 2012. However, this now puts further pressure on LightSquared to file for bankruptcy within the next two weeks, so that the December 15 revision to the Sprint agreement does not fall outside the 90 day bankruptcy window for review of recent contracts and payments.
Fundamentally I think that what both of these problems come down to is that in its negotiations LightSquared appear to have only considered the outcome if they were successful in deploying a network. I’m told that Inmarsat certainly focused most intently on the default provisions, because they always expected LightSquared to fail, and Sprint appear to have done likewise in demanding an upfront payment and then concentrating on retaining that money once LightSquared failed to get approval for their network. Both Harbinger and LightSquared were truly putting it all on red.
