This is a recommendation for the purchase of Arch Wireless, Inc. 12.00% Subordinated Notes Due 2009, which is currently trading in the mid to high 50s.
Arch Wireless is a paging company that provides wireless messaging and information services, operating in the U.S., U.S. Virgin Islands, Puerto Rico and Canada. Arch provides traditional one-way messaging services as well as advanced wireless data and two-way services. Arch has grown primarily through the acquisitions, the two largest being MobileMedia in June 1999 and PageNet in August 2000. After suffering from an overwhelming debt burden that could not be serviced by the declining cashflow stream, Arch filed for Chapter 11 bankruptcy protection in December 2001. At that time, the Company had $1.37 billion of principal amount of bank claims. Arch emerged from bankruptcy in May 2002 with a new capital structure consisting of $200 million of 10% Senior Secured Notes, $100 million of 12% Senior Subordinated PIK Notes and 20 million shares of common stock.
The paging industry has witnessed numerous bankruptcy filings within the past 1-2 years. This was largely a function of increased borrowing to support network expansion, particularly in the two-way messaging business. The two-way business was basically a failure, as the paging companies faced intense competition from alternative two-way messaging systems, such as Blackberrys and cell phones. As a result, these paging companies could not sustain the level of debt they had assumed. This, along with a declining in the number of traditional paging subscribers, led to a reorganization of the industry. The decline in Arch’s subscriber base is reflective of the entire industry, as units in service declined from 11.6 million at the end of December 2000 to 6.0 million at the end of September 2002.
Although unit decline is a concern, this investment is predicated on debt reduction. The Company is on track to generate well over $200 million in EBITDA for fiscal 2002, with approximately $90 million in capital expenditures. All available free cash is then swept for debt reduction on the 10% Senior Notes. By year-end, Arch will have paid down $90 million of the $200 million face amount of the Senior Notes, which has gradually moved to par (after trading in the 40s about 4-5 months ago). At year-end, Arch will have $110 million outstanding on the Senior Notes and $106 million of the Subordinated Notes. This would imply a total debt-to-EBITDA ratio of slightly less than 1.0x (I think Arch will come in just above $220 million in EBITDA for FY2002) and 1.6x on an after-capex basis. Based on the reorganization plan, there are strict limitations on capex, so there is little danger that an over-investment in infrastructure will negatively impact the debt payback. Also, the rate of decline in subscribers has slowed, as the business moves toward a core base of traditional paging subscribers. Unless we see an enormously precipitous decline in the units in service, the Company should have little problem in repaying substantially all of its debt within the next two years (which makes the equity a potentially good story as well).
I believe that within the course of the next year, all of the 10% Senior Notes will be redeemed and the 12% Notes will see continued appreciation in price and will be trading close to par by year-end 2003.
The ongoing catalyst is the continued aggressive paydown of the Senior Notes, the benefits of which will flow directly to the Subordinated Notes.