What a bizarre day in the world of LightSquared, where it appears nothing is ever as it seems! First of all, a comment yesterday on my last blog post gave some hints as to a completely different way to think about why Charlie Ergen might be interested in acquiring LightSquared’s spectrum, despite the current roadblock imposed by GPS interference concerns. Specifically, why couldn’t LightSquared’s L-band MSS spectrum be repurposed as uplink-only spectrum and then paired with the DISH 2GHz spectrum, which could all be converted to downlinks (a proposal already made in the FCC’s 2GHz NOI)? Then Ergen would have access to a total of up to 80MHz of spectrum which could be authorized for terrestrial use (four 10MHz uplink blocks in the L-band and two 20MHz downlink blocks in the 2GHz band).
As I pointed out in my reply to that comment, there are certainly some GPS interference concerns expressed by the NTIA over handsets operating in the portion of the L-band uplink closest to GPS (1627.5-1637.5MHz) and presumably these concerns would be considerably greater for uplink use of the 1545-1555MHz block because it is even closer to GPS. It would also be very hard to develop handset filters which could comply with the onerous ATC out of band emissions limits above 1559MHz (something that is easier to address for downlink use on a tower, where physical size and power requirements are less of a constraint), presenting further issues for uplink use of the 1545-1555MHz block. However, even if these two bands were dropped from the initial deployment plan and only three of the four bands were used eventually, DISH could still benefit hugely from having access to 40MHz of downlink spectrum instead of 20MHz. Indeed DISH might even be able to sell off or lease some of this spectrum to another operator and still build a network.
This guesswork seemed to be supported by LightSquared’s April 25 letter to the FCC, asking for the L-band to be addressed within the 2GHz NOI, so that “cross-band” solutions could be considered. The counter-argument is that any such change would obviously delay the process of authorizing and then building out DISH’s network considerably (most likely by 1-2 years), and therefore might not be acceptable to either DISH or to the FCC Chairman (assuming he is focused on maximizing the speed with which the 2GHz spectrum is brought into terrestrial use).
However, later in the day, news emerged that Harbinger and the debtholders have agreed on a change to the First Lien Debt Agreement, adding DISH specifically to the list of Disqualified Parties who are not allowed to purchase the debt (this section previously just referred generically to strategic purchasers). That would suggest Harbinger are not interested in some form of accommodation with DISH along the lines of the above “cross-band” spectrum pairing.
Even more bizarrely, I have had people insisting to me that it is definitely not DISH who is the purchaser, and Ergen is not formally denying an interest simply because he wants the LightSquared debtholders to be even more confused about his intentions, while he moves ahead with his plans in the 2GHz band. It was indicated to me that various people have already been spreading misinformation, for example when the WSJ was told that Falcone had agreed to step down (which I’m told he hadn’t), and when the New York Post was told that Falcone had not been presented with an economic proposal by the debtholders (which I’m told he had). According to this version of events, the New York Post story that “Ergen bought the debt” is similarly misleading and may even have been encouraged by Falcone and his advisors in order to persuade investors that there is strategic value in the spectrum. Of course that version of the story might just be wrong as well.
At this point what we do know is that Sound Point has a deep pocketed backer who is trying to acquire a significant amount of the LightSquared debt. If it’s not Ergen, then it is very hard to understand who would have a strategic interest in the spectrum at anything close to the price they are paying. We don’t know the intentions of the buyer, but it seems that they are probably not friendly towards Harbinger and would presumably therefore seek to force LightSquared into bankruptcy on Monday when the waiver expires. Whether they will gain support from other debtholders in doing that remains unclear, but it does seem that Falcone’s threat of a voluntary bankruptcy may not be give him as much power to dictate the outcome of this week’s negotiations as first thought. Most people certainly seem to think that another extension of the negotiations beyond next Monday is fairly unlikely and a resolution one way or another will be reached by then.
As a result we seem set for another few days of briefing and counter-briefing, in a situation where almost no-one knows who is telling the truth and who is bluffing. With $1.6B of debt and billions more in equity at stake, it really is going to be a game of high stakes poker this weekend.
Last year most attention was focused on the October 2010 bankruptcy of TerreStar Networks, which owned the 2GHz satellite assets that Charlie Ergen purchased last June for $1.4B. Much less attention was paid to its parent, TerreStar Corporation, which filed for bankruptcy in February 2011 and owned the 8MHz of spectrum in the 1.4GHz band that was leased to LightSquared in September 2009.
The reorganization plan for TerreStar Corp contemplated that this lease (under which TerreStar receives $2M per month) would remain in place, and the company would be handed over to its preferred shareholders, led by Highland Capital, Solus and Harbinger. However, this plan now seems to be on the verge of unraveling after Harbinger dumped its Series B preferred shares (which had a face value of more than $100M) earlier this year (keeping only the worthless subordinated Series E shares), presumably so Harbinger could repay its $400M UBS loan at the end of January.
Now TerreStar Corp has been forced to postpone the confirmation hearing (originally set for April 11) and hire counsel to help figure out what options remain for the 1.4GHz spectrum. Most observers appear to agree that the Harbinger lease was above the market value for this spectrum, and Harbinger appears to have been unable to find anyone interested in taking over the lease when it attempted to monetize the spectrum in January this year. It remains unclear what recourse TerreStar Corp might have to sue LightSquared to recover the lease payments, given that LightSquared Inc, which controls the lease and is the parent of LightSquared LP (where most/all of the cash is held) appears to have few resources of its own.
So now the question is what happens next for TerreStar Corporation? Will the 1.4GHz spectrum be offered for open sale? Do Solus, Highland and West Face really want to own this spectrum? How will a valuation (and a potential cramdown of Elektrobit, which is an unsecured creditor of TerreStar Corp) be agreed without the lease? Whatever happens, this certainly looks like yet another mess that Falcone has got his one time partners at Solus into.
Since news emerged yesterday that Carl Icahn had sold his $250M of LightSquared’s first lien debt at around 60 cents on the dollar there has been feverish speculation about whether someone else is backing Sound Point Capital, the small investment firm that bought the debt. Today that led to the price of LightSquared’s debt being bid up to almost 70 cents on the dollar, as investors wonder if a strategic player is interested in the company.
Attention has focused on Charlie Ergen, because of his record of doing the same with DBSD and TerreStar last year, with the Reuters article which broke news of the sale indicating that Ergen was previously an investment banking client of Sound Point’s principal. Notably, in both cases Ergen acquired debt of the companies before bankruptcy and then bought the assets out of bankruptcy, with the debt investors ultimately getting paid back at par. Ergen was even asked on today’s DISH results call if he was “interested” in LightSquared’s spectrum, but deflected the question by responding that DISH has all the spectrum they “need”.
Icahn was not regarded as a spectrum expert, and it was with some justification that Harbinger argued 10 days ago that “they doubt Icahn would get better results from DC”. In contrast, Ergen has an intimate knowledge of the regulatory issues and currently appears to be far more in the FCC’s good books than Falcone (exemplified by Ergen’s ability to secure a meeting with the FCC Chairman on January 4, when Falcone was relegated to only meeting with officials on the same day). Indeed LightSquared’s investors would very likely welcome the involvement of Ergen with open arms, and would certainly trust Ergen far more than Falcone to negotiate a way out of their current dilemma, despite Falcone’s claims in his comments to an earlier blog post of mine that:
Everyone knows Ergen is not going to build out a network. No one trusts him, including the FCC. They are not going to put their eggs in that basket because they know he will make them look foolish. It is inevitable. This guy, as smart as he is, will never build the network. He is using it as bait so one of the big guys step up and attempt to pay him for a dwindling subscriber base. Dish and Ergen are on the downward slope of a steep hill and he knows that, hence his aggressive acquisition tactics over the last 12 months…. stay tuned….
Of course we don’t yet know who, if anyone, is behind the purchase of Icahn’s holdings. Even if it is Ergen, then he could have a range of motivations, ranging from a defensive move to ensure LightSquared doesn’t disrupt the current FCC proceeding to authorize terrestrial use of the DBSD/TerreStar 2GHz spectrum, to a desire to help the FCC out of a hole, all the way to seeing a long term opportunity to make the L-band spectrum useful for terrestrial service. Indeed several of these factors could be in play simultaneously.
UPDATE: The New York Post is now reporting that Ergen was the buyer and he picked up another $100M of debt last week in addition to Icahn’s $250M holding.
However, one important consideration to bear in mind when drawing parallels with DBSD and TerreStar is that in those cases the spectrum was owned free and clear (whereas LightSquared has an expensive lease contract with Inmarsat, albeit one that is currently on hold) and (in the absence of a spectrum swap) the GPS interference problems in the L-band mean it will be many years before even a portion of the band (likely at most 20MHz) is usable. Both those factors will significantly depress the value of LightSquared’s spectrum relative to DBSD and TerreStar (where Ergen paid $1.4B-$1.5B for 20MHz of spectrum from each company) and make it much harder to justify paying anything close to the $1.6B par value of LightSquared’s debt simply to acquire LightSquared’s spectrum assets.
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.
After today’s FCC Open Meeting there is a lot of speculation about the content of the 2GHz NPRM and NOI which is expected to emerge very shortly. The FCC indicated that it would reallocate the entire 40MHz of spectrum (2000-2020MHz uplink/2180-2200MHz downlink) to terrestrial services, redesignating it as the AWS-4 band. Many have assumed that this means that DISH would secure unlimited terrestrial rights across the whole band, with no givebacks, but the FCC was careful to indicate in the press conference afterwards that “flexibility applies across the whole band” but not that DISH will get flexibility across the entire 40MHz.
UPDATE: The NPRM has now been released and it appears that there is no definitive requirement for DISH to give back any spectrum, and it would simply be allocated terrestrial licenses nationally in exchange for a buildout criteria of 30% of the population within 3 years (not dissimilar to the 100M POPs agreed to by LightSquared) and 70% of the population in each economic area within 7 years (a somewhat less onerous requirement than LightSquared). Though the possibility is raised that DISH will move up by 5MHz and possibly even give up another 5MHz of uplink spectrum, there is no mention of a larger amount of spectrum being returned to the FCC in exchange for these terrestrial rights, suggesting that Charlie Ergen has played a stunningly good hand of poker to achieve such a result. Of course, it would not be in the least bit surprising to see accusations of a windfall emerge, just as they did with LightSquared.
The FCC has also accompanied the NPRM with an NOI, which proposes a “variation of the AWS-4 band plan” intended to “extend the AWS-1 and PCS spectrum with 65MHz of usable bandwidth”. This alternate plan involves converting the MSS uplinks to downlink spectrum, so that the entire 1995-2025MHz band would be additional PCS downlink spectrum. In exchange the MSS licensee could be granted access to the 1695-1710MHz band which would be paired with 2180-2200MHz as an AWS extension band. This hardly seems to be something that DISH would be keen on, given that it would involve defining another non-standard band class, and would not be compatible with the existing 2GHz satellite services, which DISH might at some point want to explore in Europe.
What is striking is that the FCC’s proposals are hard to reconcile with the requirement in the payroll tax bill back in February that the FCC should identify a “additional 15MHz of contiguous spectrum” to be auctioned, which is why I had assumed the NOI would propose that DISH gave up 10MHz of spectrum and moved its uplinks up by 5MHz into the 2020-25MHz J-block spectrum, as I indicated back in February.
In this context it is hard to see why the FCC bothered with the NOI, unless it is to use this to put more pressure on DISH to give up part of its uplink spectrum. I had guessed that the NOI would be the FCC’s preferred outcome and so NPRM would propose far more unfavorable terms for DISH. In other words, the NPRM would be “designed to fail” in order to drive all parties to a solution which would free up a greater amount of spectrum for auction.
Now we will have to see how commentators react to the NPRM. Could further pressure be brought to bear over the potential windfall, leading to a proposal that DISH gives up an extra 5MHz of uplink spectrum and create the 15MHz block of spectrum for the FCC? If not then the FCC will presumably have to look elsewhere for spectrum to meet the Congressional mandate, unless it perhaps claimed that it is not possible to auction the H-block due to interference concerns in the 1915-1920MHz band, and so the 1995-2010MHz block would meet this mandate. More importantly, the FCC appears to be betting that DISH will actually build out a network to introduce competition to the US wireless market, and so if the end result (after the November election) is a takeover bid from AT&T, it will be interesting to see what attitude the FCC takes to such a bid. If that occurs, and goes through without any further givebacks, then the FCC might very well be seen to have failed in its attempts to maximize the value of spectrum for the public interest. On the other hand, perhaps that could be the point at which an additional 5MHz of spectrum might be given up.
FURTHER UPDATE: As an aside, the NOI doesn’t appear to do much for LightSquared’s hopes of creating substantial incremental value for its Crown Castle lease in the 1670-75MHz block. LightSquared is apparently busy trying to extend its financial runway, but it may now be more difficult to avoid the looming financial crunch at the end of the second quarter of 2012, when LightSquared must repay a roughly $300M loan to its creditors.
