A union leader recently told the papers that eircom could be on the brink of collapse within six months. Obviously the union has suddenly become aware that there is a large amount of debt overhanging the company.
The fact that eircom has a lot of debt is well known. The actual structure of that debt is less well known. The role of the unions in running up the debt is not talked about much at all. However, these are all key to understanding what will happen next at eircom.
The structure of eircom’s debt that is interesting is that some of it is structured as ‘PIK’ notes. PIK stands for ‘payment in kind’. What this actually means is that this is a loan that you don’t have to pay any ongoing interest on. The interest is rolled up until the end of the loan period. This is a bit like a ‘balloon payment’ on a car loan. You have to come up with a big chunk of money at the end of the deal (which you usually get by selling something).
So the PIKs are sort of a time-bomb for eircom. They don’t ‘blow up’ until 2017, but when they do, there has to be a plan for refinancing them. Of course, the very existence of these PIK notes makes it very difficult for the company to borrow more money. Would you lend money to a guy who had a big balloon payment coming up on his new BMW?
So what happened to this money? What infrastructure was it invested in? Which fiber optic links was it used to build? Which exchanges were upgraded?
The answer is not pretty. Rather than being invested in building a better phone and Internet company, the money was largely used to make payments to the shareholders, both Babcock, who used to control the company, and the eircom ESOP, which represents employees who hold shares in the company through a tax-efficient trust structure.
So what happens now? Well first of all, STT, part of Temasek Holdings, the Singapore State investment holding company which just bought eircom has some pretty brainy people working for it. They knew what they were getting themeslves in for, debt-wise, and they certainly have a plan for getting out of it.
It is hard to know what that plan is, but it will probably involve quite a bit of pain, both for ESOP shareholders (i.e., employees and former employees who have benefited from hundreds of millions of euros in payouts over the years) and employees (the people who actually do the work). For a start there are going to be serious cutbacks in the workforce and the operations. This is inevitable, when a large proportion of the eircom lines in the ground are not actually connected anymore and are not generating any income at all (around 90 percent of homes once had phone lines from eircom; that’s dropped to around 65 percent now). Soon eircom will not even be the biggest player in irish telecomms. The decline of landline penetration, the rise of UPC, plus the growth of Vodafone through acquisition will soon put eircom into second place.
There are also not going to be any more ESOP payouts. But it could be worse than that. The ESOP may face a ‘cash call’ to maintain its shareholding in the company. This means that the ESOP will be asked to put in money at the same time as STT puts in money (as it inevitably will have to do, sooner or later). Cash will not be an issue for STT. They have loads of it, and they are obviously prepared to invest. Not unreasonably, they will expect the ESOP to put in more cash to maintain their shareholding. However, the ESOP has no cash, and is unlikely to be able to raise cash from its members. They will have difficulty borrowing using their shares as collateral, because their shares are now worth very little.
So the end of it will be that the ESOP’s influence will be greatly reduced as the shares they own get diluted. I would speculate that STT and the new management will introduce a new and generous share option scheme, but it will be a very different animal from the ESOP.
But will eircom go wallop as the unions say is possible? Unlikely. Firstly, eircom still has some decent cash flows. Secondly, STT didn’t buy eircom in order to let it go bankrupt. They bought it to rebuild and profit from its brand and its valuable physical assets and real property rights. STT could conceivably decide to put eircom into ‘examinership’, a court supervised arrangement to restructure the company but it is really unlikely that they would allow things to go that far, if only because it would put their existing investment at risk. (In an examinership, the lenders, including the owners of those PIK notes, would end up with a large say over the future of the company, and would probably end up owning it.)
But even without an event like an examinership or liquidation, eircom is going to change beyond recognition.
Disclaimer: I occasionally advise in relation to the Irish telcomms sector.