Bankers close to the negotiations between the shareholders of Reach and its financing syndicate have revealed that new terms on the troubled company's debt could be agreed within days. "It is all ready for signatures and we could sign in a week or so," says one banker.
On Friday, PCCW and Telstra revealed they had written down the value of their joint stakes in Reach, the undersea cable join venture the two set up in 2000. PCCW wrote off Reach's goodwill of HK$8.26 billion ($1.06 billion) leaving its book value of HK$3.96 billion on its books. Telstra wrote the whole lot off.
Speaking on Friday, PCCW management revealed that Reach had been having a hard time meeting the numbers it had predicted in its original business plan. "This is a difficult and volatile environment in the undersea cable business at the moment," said Mike Butcher, COO of PCCW.
But explaining why PCCW was keeping the book value, Alex Arena, the company's CFO noted, "we are concerned at the volatility of the sector, but we do not know if this volatility is a long term trend. Therefore we will not make a decision on writing off the book carry value [yet] but we will write off the goodwill now."
Reach took out a $1.5 billion syndicated loan in February 2001 to finance its ambitions. The loan was split into three tranches of three, five and seven year maturities. The tranches have bullet repayments and so the first $300 million slice is due back next February.
The arrangers of the loan were Barclays Capital, Chase Manhattan (now JPMorgan), Citibank, Rabobank, CSFB, HSBC, Sanwa and UBS Warburg. Arena confirms that Reach has been entirely current with is interest payments on this loan, although the company has received a waiver on some of the covenants attached to it.
Some of the issues surrounding the loan included stipulations that Reach would become an investment grade credit and undertake an IPO, something that looks a long way off in the current operating environment. This environment has been made considerably worse by the activities of the bankrupt undersea cable operators such as Asia Global Crossing and Flag, which have been able to dump capacity on the market and drive down prices while under the protection of Chapter 11 Bankruptcy proceedings.
For Reach, its shareholders and its lenders, this has markedly changed the environment in which the company is operating and so it seem only sensible to seek a reworking of the company's financial structure. According to the banker, negotiations have been going on for three months, after both sides realized that the business was experiencing "a meaningful departure from the business plan."
The terms of the new financing agreement are likely to include some step-ups in interest payments in return for an extension of the maturity profile. This will give Reach more flexibility to perhaps consolidate the sector using the $300 million that it is due to repay to the banks next February.
It is unlikely the banks will demand the loan becomes full recourse to the shareholders because Reach is said to be generating cash as well as some profit, despite the miserable operating environment. This is largely due to the fact that nearly 70% of its traffic comes from its shareholders.
Indeed Telstra cannot route a call out of Australia without using Reach (unless it wants to use Optus, which would be unthinkable). This gives the banks a certain comfort that the credit of Reach is to a large extent the credit of the shareholders and this will make them very unlikely to walk away from Reach and its debt.
One further sign of commitment from the shareholders to a prudent reworking of Reach is the appointment of Dick Simpson to be the new CEO of Reach, replacing Alistair Grieve. Simpson is the president of Telstra's international operations and is very highly regarded in international telecom circles.
The write down, the recut of the loan and the new appointment are evidence that PCCW is returning to its recent prudent ways after its well-publicised flirtation with buying Cable & Wireless. PCCW had built up a growing stock of investor and lender goodwill through its prudent cost cutting and debt reduction activities, which was nearly frittered away on the back of a new acquisition spree.
According to sources, that goodwill is likely to be reflected in the new terms of Reach's financing package.
