After a long and bumpy ride, Forstmann Little & Co. has agreed to walk away from its proposed $800 million rescue package for XO Communications. Forstmann Little, along with Telefonos de Mexico (TELMEX), which was on the hook for half of the bailout, both agreed to pay XO $12.5 million in order to procure a release from any claims related to their original investment agreement. The settlement is still subject to bankruptcy court approval.
Forstmann first got involved with XO Communications, formerly Nextlink Communications, in January 2000, with an agreement for an $850 million convertible preferred stock commitment. At the time, XO appeared to be on the right track, recording significant and steady revenue growth. Forstmann followed up its initial investment with another $400 million preferred stock commitment in July 2000 and in April 2001 made a $250 million equity investment and reset the strike price of the preferred stock.
XO and other competitive local exchange carriers (CLECS) were once viewed as enticing alternatives to the incumbent legacy exchange carriers (ILECs). However, these companies borrowed heavily to build infrastructure and construct costly fiber-optic networks. And as banks struggled with problem loans, they grew increasingly gun-shy in lending to the telecom sector. Further, the telecom companies were unable to draw enough traffic to pay down the debt, leading many to file for bankruptcy, including XO, Global Crossing, Williams Communications and others.
From Bad To Worse
As Forstmann Little’s investment began to sour, grumblings over the deal grew more vocal. The firm decided to write off its $1.5 billion investment in XO, which represented the largest private equity write-off of all time.
In December 2001, Forstmann announced its intention to salvage its investment, outlining plans to invest another $400 million in the company, boosting its stake to 39% from 12 percent. TELMEX was to provide the same investment and net the same 39% in equity in return. Had the restructuring gone through, XO would have been able to eradicate $5.8 billion of debt and preferred stock, including Forstmann’s $1.5 billion preferred investment. Around this time, Forstmann also elected to discontinue management fees on the investment in a move to temper the growing agitation from its limited partners.
However, the rescue plan drew criticism from holders of XO bonds. Entering the picture was Carl Icahn, who, with a $750 million stake in XO bonds at the time, offered to invest $550 million into the company for a 55% stake. However, with XO still set on the Forstmann / TELMEX offer, he decided to pull the bid in May. This past September, though, Icahn did manage to grab a significant stake in XO, through his purchase of 85% of the $1 billion senior secured debt facility from XO’s bank syndicate.
Meanwhile, the State of Connecticut added fuel to the fire by suing Forstmann for breaches of fiduciary responsibility and violations of the contract clause and securities law violations. While the still-unresolved allegations were not centered on Forstmann’s investment in XO, the accusations underscored the firm’s failings in the telecom space, including money lost on its McLeodUSA investment.
Forstmann initially articulated its disinclination to move forward with the rescue plan in a letter to XO’s lawyers that was received in June. XO “flatly” rejected Forstmann’s insinuation that it would be “virtually impossible” for XO to meet its obligations to the deal. Further, there was speculation that a drastic decline in XO’s valuation made Forstmann Little even more wary of the risks involved. Noelle Beams, the treasurer of XO, conceded in a call to Buyouts that the Forstmann/TELMEX agreement had carried a $2 billion implied valuation for XO, which doubles the implied valuation of XO’s new “Plan B” reorganization arrangement.
However, after both Forstmann and Telefonos de Mexico publicly announced their intention to walk away from the deal, a bankruptcy judge ruled against the two firms and enforced the validity of the $800 million agreement. Forstmann Little reportedly toyed with the idea of invoking a material adverse change, or MAC, clause, which ostensibly would have cited an adjustment in XO’s revenue and EBITDA forecasts.
Beams does not believe Forstmann would have been successful had it attempted to invoke an MAC clause, and she notes the threat of such a move was likely the product of press speculation.
In XO’s new reorganization plan, the company will convert $1 billion in bank debt into stock and XO will issue $250 million in new equity in an offering to bondholders. Additionally, the company will eventually issue $500 million in new junior secured debt. The alternative arrangement has Icahn’s backing.
Forstmann, meanwhile, will still hold its original 12% investment in the company.