Sprint Nextel Corp's plan to pay down debt would give the company much greater financial flexibility, but the cancellation of its planned convertible sale suggests any capital raising for debt reduction will not come at the expense of shareholders.
The third largest US wireless phone service on Wednesday announced a $3 billion convertible offering that sent its shares down as much as 12.6 percent, and warned subscriber defections would swell in the current quarter. However, Sprint cancelled the deal on Thursday, saying the terms offered for the securities were not favourable to the company.
"We believe that the stock reaction following the announcement was the main reason the company pulled the offering," said CreditSights analyst Ping Zhao. The convertible sale could have diluted the value of existing shares by 10 percent to 15 percent, according to Stifel Nicolaus analyst Chris King.
Meanwhile, debt markets reacted positively on the expectation that proceeds would be used to pay down debt. The cost to insure Sprint's debt with credit default swaps fell 51 basis points to 332 basis points on the planned sale, before retracing after it was cancelled to 359 basis points on Friday, or $359,000 per year for five years to insure $10 million in debt, according to Markit Intraday.
Sprint said it plans to reduce gross debt by at least $1 billion by the end of the third quarter but has not said what debt it will repay. Analysts predict its likely to pay back some of its revolving credit facility.
Terms, known as covenants, in the $6 billion credit line require that Sprint maintain leverage of no greater than 3.5 times, according to CreditSights' Zhao. The leverage is measured as "total indebtedness" to earnings before interest, taxes, depreciation and amortisation of the last twelve months.
Though the company is not likely to breach this ratio, which could have a disastrous impact on its business, reducing debt outstanding on the revolver would give the company more breathing room to focus on turning around its business. "Right now a lot of the decisions they are making is trying to make sure they don't breach the covenants, cut down on capex and they are trying to do everything they can to be free cash flow positive," Zhao said.
"If you can reduce the debt somewhat it will help you, without having to worry if the ratio is getting close," she added. Cross default triggers in the covenants mean that if the terms are breached Sprint could be in technical default on all of its debt. It would also be unlikely to renegotiate with banks terms on the unsecured credit facility that are as favourable as its existing line.
Sprint has struggled to stem customer losses amid service problems, weak marketing and the economic downturn, which especially hurt its credit-challenged customers. Even without increasing its debt load, lower earnings are increasing its leverage measure, which currently stands at 2.9 times, and could rise to the 3.2 times area, said Zhao.
Sprint posted a loss of $344 million for the second quarter, or 12 cents a share compared with a profit of $19 million, or 1.0 cent a share in the year ago quarter. Revenue fell 11 percent to $9.06 billion.
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