High-Yield Debt Market in Rural Business Strong

In the words of investment banker Frank Gallagher, the local phone companies were viewed as “boring cash cows.” Then, a throng of nascent phone companies and Internet carriers exhausted their cash reserves and took a plunge into either Chapter 11 bankruptcy proceedings or extinction.

Gallagher, managing director of telecommunications investment banking for Legg Mason Inc., says investors now hold in high regard the rural phone companies’ steady cash flow.

“As a general rule, it is considered to be a relative oasis of stability in the telecom world,”

Gallagher says. “Access to capital should not be these companies’ primary concern. There is absolutely access to capital.”

Finance officers say the debt markets particularly are robust, and Gallagher says most CFOs would rather issue debt than equity because debt is only temporary. The high-yield bond market — a common way to raise debt — is hot, finance officers said at OPASTCO’s (Organization for the Promotion and Advancement of Small Telecommunications Companies) 41st Annual Winter Convention in January.

Gallagher says bonds are trading at par or above the price at which they were issued. Bonds have been appreciating in part because of a perception of good industry fundamentals and a general recovery in the economy, says Peter Saulnier, CFO at Country Road Communications. Clay Bailey, treasurer and vice president of CenturyTel Inc., says 10-year bonds the company issued in 2000 have increased 21 percent since their original issue price. “All of our bonds are trading above par,” he says.

Falkenberg Capital Managing Director Robert Paige says the high-yield debt of rural wireless carriers is trading at about 70 cents on the dollar, up from single digits.

Gallagher says banks also are allowing rural LECs to leverage themselves. He says the specialty commercial banks such as the Rural Telephone Finance Cooperative are willing to lend up to four and a half times EBITDA (earnings before interest, taxes, depreciation and amortization), down from six or seven times EBITDA in the telecom heyday of the late ‘90s. The “lending market has stayed pretty stable,” he says.

CenturyTel put in place a $533 million bank facility at attractive rates in August 2002, Bailey says, adding the steady cash his company generates is attractive to banks. CenturyTel generated $438 million in 2003 free cash flow, which is defined as net income plus depreciation minus capital expenditures. The “markets are stable and [we] feel like we could obtain at least the same pricing for a similar facility,” the treasurer says.

Raising money in the private equity market is more difficult, some finance experts say, because private equity firms want an exit strategy and a pretty substantial return on their investments. It is “certainly tough to get the group excited,” Paige says.

Saulnier, of Country Road Communications, says the equity firms are seeking a 20 percent to 30 percent return, depending on the firm and the level of risk they are willing to take. The problem: The industry is growing only at a single-digit rate, so companies either must put financial leverage on themselves to get those returns perhaps by completing acquisitions and expanding as CLECs, or “do something extraordinary,” Saulnier says.

Finance chiefs say the public equity market is among the weaker aspects of the broader capital market. John Butler, CFO of VALOR Telecommunications Inc., says private values are higher. Bailey says the public market is fickle.

“There’s always going to be fluctuations in the equity market,” he says. “To say it’s a weak link right now — I don’t know [if] I would go that far.”

However, Bailey acknowledges CenturyTel’s stock is trading at a price lower than the company would like.

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