Strange bedfellows — the Marconi story

  • 01 Sep 2002
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Misery, as Trinculo told us in Shakespeare's Tempest, acquaints a man with strange bedfellows. And in recent months they have not come much more miserable than Marconi, or its investors and bankers.

The Cinderella version of the Marconi story, or saga, would have it that restructuring leaves the way clear for the company to rise, Phoenix-like, from the ashes of devastation created by its previous management, and for everybody to live happily ever after.

With the Marconi name, in financial markets, things have seldom if ever been that simple. "Scandal, law suits, arbitrations, disputes with government departments, and quarrels with shareholders have followed one another in fairly regular succession," was what the Economist had to say about the old Marconi Wireless Telegraph as long ago as October 1928. Historically the name has embarrassed people loftier than the analysts who in March 2000 were advising that investors continue to chase the shares at £12.50 apiece - UK prime ministers Lloyd George and Winston Churchill among them. Against that historical background, it is a mystery why the new Marconi ever chose the name in the first place.

The bare bones of the Marconi restructuring have, by now, been well documented. Bank creditors and bondholders due some £4bn have taken control of 99.5% of the Marconi Corporation, while shareholders have been left with a token 0.5% of the company which, it is planned, will be listed early next year.

The problem with the Marconi "solution" as it stands today is that it throws up many more questions than answers - and those questions are as relevant to any number of companies undergoing similar restructurings involving debt to equity swaps, such as NTL and Telewest.

The first and most obvious of these is whether, from an operational standpoint, the reconstructed Marconi can survive and prosper any more efficiently than the self-destructing Marconi of a year or two ago. Although the company's advisors assert with confidence that it will survive, it is a question that, in the current market environment, is almost certainly impossible to answer, and it is certainly not a question that most equity analysts are equipped to address with any degree of credibility.

Hindsight is a wonderful thing, but it is now painfully apparent that with one or two notable exceptions (such as Collins Stewart), the equity analysts following Marconi two or three years ago did not have the remotest idea about how to value the company or what its prospects were.

In an ideal world as far as its investors are concerned, a knight in shining armour is going to ride over the hills and buy Marconi, lock, stock and barrel for a tidy sum paid in cash. That wonderful outcome would give investors in the company a 100% cash exit, but any stakeholder hoping that this will happen would be well advised not to hold his breath. "The fact of the matter is that Marconi's recent history is one of such upheaval that none of the logical trade buyers are likely to step in," says one banker. "In any case, even if they wanted to they are themselves in such dire financial straits that they wouldn't be able to pay an acceptable price. Most of its competitors will be dearly hoping that Marconi quietly goes out of business and shrinks the total market capacity, but now that a restructuring has been agreed upon that does not look very likely either."

Here to stay?

The reality, therefore, is that Marconi in its reconstructed form is here to stay, for the foreseeable future at least, and that its new management faces a formidable challenge if it is nurse the company back to health. Analysts say that the company has made an encouraging start in this respect, selling off a number of non-core assets and refocusing on its core European strengths.

Nevertheless, obvious question marks remain over the Marconi future. One of those concerns the nature and agenda of the investors that now control the company's equity. Those investors are very different animals from the institutions that subscribed in March 2000 for Marconi's debut Eu1.5bn dual tranche issue which, with its A3/BBB+ rating, now seems like a distant memory. Most of the pension funds and insurance companies which bought those bonds will have been long gone, and into their shoes have stepped muscular US-based hedge funds and specialist distressed debt investors, such as the New Jersey-based Appaloosa, which now has a large position in Marconi bonds.

Those investors will have been attracted by a number of factors, not least the fact that the bonds they acquired to give themselves a foothold into the company rank pari passu with the bank debt, given Marconi's investment grade when it originally issued.

As one observer says, in the absence of this equality with the banks, the Marconi bonds would probably have become close to worthless. The same observer also says that the seniority of the bondholders in the Marconi restructuring discussions made them even more fractious than would normally be expected - for obvious reasons.

With regard to its new, strange and possibly hostile bedfellows, David Wyles, managing director at Greenhill & Co in London, says that this is now the natural investor base for a company in Marconi's circumstances. "When a bond starts to trade at, say, 50 cents in the dollar it is pretty clearly saying that the market is expecting the company to implement a restructuring because it can no longer service its debt," he says. At that point, says Wyles, the bonds that are owned by insurance companies are either transferred to the workout groups within those companies, or funds that specialise in buying distressed debt come in and start to buy them up. "And the reason the specialist funds come in is that they like the value proposition of the assets as a whole. At that stage they are often making a strategic decision to become equity investors in the business."

Nevertheless, the composition of the new investor base worries some observers. "The company's new shareholders will have to understand the challenges facing the CEO," says one, "and to establish a clear set of guidelines and objectives for him to work with. That may be quite difficult when the company has such a diverse group of investors that are obviously going to be more interested in making a quick return than sticking with the company over the long term."

Double-edged sword

The same observer believes that the low entry price at which many of the specialist investors are coming into restructuring situations like Marconi and NTL is a double-edged sword. "On the one hand it is a good thing, because their downside is limited. Because specialist distressed investors are coming in at such a low price they probably don't have much to lose which may allow them to be more flexible and tolerant in terms of allowing the company to rehabilitate itself," he says.

The flipside of this, he adds - stressing that this may not be applicable in the cases of Marconi or NTL - is that investors picking up exceptionally cheap distressed assets may be simply helping to delay the inevitable. "My worry is that some companies that are being rescued via debt to equity swaps may not deserve to survive," he warns. "Liquidation may be a preferable option because of the fundamental flaws in their business plans. If we wind the clock forward two or three years I wouldn't be surprised to see some of these companies that have been restructured via debt to equity swaps going through a second restructuring phase before ultimately being wound up."

Assuming that Marconi does not fall into this camp, another prerequisite for the company going forward, says one restructuring practitioner, will be to recognise that its circumstances have changed, very probably for good.

"It is absolutely essential that companies like Marconi recognise that they can't go back to the old model of growth, refinancing and more growth, because that will just create the old problems all over again," he says. "If it follows that strategy, the company will run out of money and be back in the restructuring arena again within 18 months. Instead, companies such as Marconi and NTL will have to earn the right to grow again."

There are a number of other pressing challenges that will emerge from conversions of debt to equity in the UK. Frederick Ng, a director at KPMG, believes that one by-product of the process is that the UK's Financial Services Authority (FSA) will need to take a close look at current insider trading regulation. "One of the main challenges facing a CEO in a restructuring is the establishment of very clear channels of communication with his new stakeholders in such a way that it does not violate insider trading rules," he says. "I think we will see this challenge arising more and more as debt to equity swaps increase in popularity, and it is a challenge that the FSA is already addressing.

"I wouldn't be surprised if we were to see the FSA modify the rules on insider trading to allow for the management in a restructuring situation to exchange more information with stakeholders. The question is: what information should be given to whom? A banker, under the terms of his credit agreement, is always going to be entitled to more information than a shareholder or a bondholder, but should that apply in the context of a debt to equity swap?"

Clearly, there is a lot of water still to flow beneath the bridges of Marconi and other similar restructurings. *

  • 01 Sep 2002

All International Bonds

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2 JPMorgan 27,208.83 91 7.37%
3 Barclays 23,714.00 55 6.42%
4 Bank of America Merrill Lynch 20,332.10 65 5.50%
5 Goldman Sachs 20,005.21 49 5.42%

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1 BNP Paribas 299.85 1 21.73%
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Rank Lead Manager Amount $m No of issues Share %
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4 BNP Paribas 522.35 4 7.49%
5 SG Corporate & Investment Banking 444.17 3 6.37%