Fructivore Investments

Those of you who watch Jim Cramer, of whom Seth Klarman said that he is a symptom of everything that is wrong with the financial world nowadays, will recall that last week he expressed approval of the safety of Windstream’s dividend. He also mentioned Fairpoint Communications (FRP), after qualifying his remarks with the fact that they have little in common apart from them both being rural telecom companies—their financial positions are completely the opposite. Fairpoint Communications has recently announced that they are defaulting on their credit facility, and that their larger creditors have agreed not to force them into bankruptcy until the 30^th.

Fairpoint recently acquired Verizon’s land lines in New England for $2.3 billion, which it turns out was a few hundred million too much, thus demonstrating the value investing principle that there are no good or bad investments, only good or bad prices. After all, anything can be at least liquidated, and with a bankruptcy in the works that is looking like a distinct possibility. Since that time, declining revenues have sunk their income, causing them to suspend their dividends in 2008 and now, it seems, to suspend their interest payments as well.

According to rumors, Windstream is a potential buyer of Fairpoint’s distressed debt, alongside several players in distressed debt. This is perfectly reasonable; inside or outside of bankruptcy, the creditors take the assets of the defaulted debtor, and Windstream certainly could do more with the assets than a distressed debt fund on Wall Street. If they acquire a powerful position in Fairpoint’s distressed debt, this will give them a suitable platform in the Chapter 11 negotiations to arrange transfer of some or all of Fairpoint’s assets to them. It is not unusual in a bankruptcy to create a situation where there will be cash and securities in the reorganized corporation available, with creditors able to choose between the two of them. So, Windstream would perhaps be able to take more securities and less cash. And, since the market for distressed debt tends to be illiquid and the valuations necessarily conservative and more geared to liquidation rather than going-concern values, distressed investing generally produces high returns to go along with the analytical and legal work involved.

Even outside an actual Chapter 11, bankruptcy is still a specter that hovers over the entire process of negotiating a debt workout. Such a workout still results in selling off profitable divisions and arranging debt-to-equity conversions to provide partial relief to satisfy creditors. Just look at AIG. In fact, in a significant proportion of bankruptcy cases, the debtor has already acquired a sufficient number of votes from the creditors of each voting class, thus making the actual bankruptcy process largely a formality, as with GM’s. So, inside or out of formal bankruptcy, Windstream has the same angle.

I should point out, though, that in the last reported quarter, high speed subscribers in the regions Fairpoint purchased from Verizon declined by 3.3%. The company attributes much of this to “cutover related issues;” in other words, they were too busy integrating their systems after the merger to actually sell their products. This is understandable, but since Windstream and every other telephone company is trying to combat loss of land lines by expanding their premium services, this is disturbing news. Their operating income, although it exists (positive operating income now or eventually is a minimum requirement for saving a company with bankruptcy as opposed to killing it), is very low, just a hair over 1% return on assets, so hopefully there is room for improvement.

Obviously, it is too early to say anything, and the rumor of Windstream even buying the debt has not been confirmed, but since Windstream has embarked on two opportunistic acquisitions already in the last year, it would be a positive development for them to be feasting on Fairpoint’s corpse alongside the other vultures. As for ourselves, we like low-hanging fruit and have no objection if some fruit gets blown off the branch by a strong economic headwind. So, if the rumor is true this is another positive for Windstream, although they might want to recall that acquiring more than they can chew is what killed Fairpoint to begin with.

And if you’re wondering about the Star Trek picture, I kept typing “Farpoint” instead of “Fairpoint,” and I couldn’t find an image that suggests a bankrupt phone company anyway.

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Investing, law by grocca