Description
For investors interested in high current yield I think that the Global Crossing UK (GCUK) $200 million 10.75% issue of senior secured notes due 2014 are an attractive investment. The notes are trading at 91 and offer a current yield of 11.80% and a YTM of 12.25%. To me the high yield market is a place to sometimes find compelling risk/reward situations with equity like returns. The analysis is much the same as a value investor would do in evaluating the equity of a company. I think GCUK senior notes provide a compelling rate of return, for investors looking for some yield, with appropriate downside protection.
GCUK is a wholly owned subsidiary of Global Crossing Ltd. GCUK provides a full range of managed telecommunications services in a secure environment ideally suited for IP-based business applications. The company provides managed voice, data, internet and e-commerce solutions to the strong and established commercial customer base, including more than 100 UK government departments, as well as systems integrators, rail sector customers and major corporate clients. In addition, GCUK provides carrier services to national and international communications service providers.
GCUK operates a high-capacity UK network comprising more than 5,600 route miles of fiber optic cable connecting 150 towns and cities and reaching within just over one mile of 64 percent of UK businesses. The UK network is linked into the wider Global Crossing network that connects more than 300 cities and 30 countries worldwide, and delivers services to nearly 600 cities, 60 countries and 6 continents around the globe.
GCUK completed the issuance of $200 million 10.75% senior secured notes due 2014 and 105 million British sterling 11.75% senior secured notes due 2014 in December 2004 when the parent company (Global Crossing Ltd) was facing an imminent liquidity threat. The new notes where issued at the U.K sub due to the fact that its business was stable, generating positive cash flow and had assets that provided collateral. The proceeds were up streamed to Global Crossing Ltd. through repayment of inter-company notes in order to fund non U.K. operations. GCUK reports in British sterling and the dollar denominated notes have been converted to British sterling at a ratio of .58 in this analysis.
Some key factors that make the notes attractive include:
1) Covenant protection that isolates, to a great extent GCUK, from the rest of the company and includes restrictive covenants that significantly limit GCUK’s ability to:
Incur additional debt
Pay dividends
Repay junior debt
Sell assets
Make investments
Engage in affiliate transactions
Create liens
Engage in some types of mergers or acquisitions
2) The notes are senior and secured obligations rank equal with any future senior debt.
3) GCUK operates with long term contracts from customers making the business relatively stable.
4) The business is currently generating EBITDA of 65 million British sterling against a current interest obligation on the notes of approximately 25 million British sterling (when you convert the dollar denominate issue), providing strong interest coverage.
5) The note indenture requires that 50% of each calendar year’s excess cash flow be used to offer to repurchase a portion of the outstanding Notes at par.
Based on #5 above, on 2005 performance, GCUK will be required to tender in early 2006 for 13 to 14 million British sterling of the 211 of outstanding Notes (in British sterling), or approximately 6.5% to 7.0% of the total. This convent provides automatic de-leveraging which enhances the position of the remaining Notes as time goes on.
As an example, assuming EBITDA and capital expenditures stay at current levels, over the next five years GCUK would be required to tender for approximately 43% of the notes. At the end of that time, remaining notes would equal 126 million British sterling. At that time, interest costs would be down to 14 million British sterling per year (against current EBITDA of 65 million British sterling). Interest coverage would be 4.6X and debt to EBITDA ratio would be 1.9X. It’s worth noting that GCUK is not expected to pay cash taxes for the foreseeable future due to unrestricted NOL’s that aggregate approximately 85 million British sterling.
A couple other ways to look at this provision and its effect is to say that with each passing year, risk to capital loss is reduced due to 1) having received a portion of my money back in form of interest 2) the assets supporting my investment becoming more valuable (through secured claims on those assets being reduced) 3) or said another way, in five years I only need 126 million British sterling of collateral value to recover my principal versus needing 221 million British sterling today. Also since in five years I will have received 54% of my money back in interest, I only need 58 million British sterling of collateral value in order to not face any capital loss on original capital (46% of the remaining Notes).
GCUK’s Business & Financials
GCUK’s business primarily provides telecommunications services to commercial customers including government, commercial, and railway customers in the U.K, which now account for 99% of total revenues, broken down by segment as follows: 50% government-affiliated, 30% enterprise and 20% railway. Approximately 85% of commercial revenue is generated under longer term contracts with a remaining average life of approximately five years. Low margin wholesale voice services have been de-emphasized and are down from 13% of revenue at the end of 2004 to now about 1% of revenue.
The U.K. telecommunications business could be characterized as very competitive but it has not seen the level of dislocation experienced in the U.S. market. The stability of GCUK’s business is evidenced by growth in EBITDA and commercial revenue in the 2001 to 2005 time period despite very competitive industry conditions generally and the Chapter 11 reorganization of GCUK’s parent (Global Crossing Ltd).
In thousands British sterling Nine Months
2001 2002 2003 2004 2005
Revenue 292 262 288 269 179
Cost of Sales 233 219 199 177 116
Gross Margin 59 43 89 92 63
Distribution 22 12 10 10 7
Admin * 130 74 54 36 39
Oper Income -93 -43 25 46 17
Depr & Amort. 51 43 42 41 29
Adj. EBITDA -42 0 67 87 46
Cap Ex 99 55 28 8 7
Unlevered -141 -55 39 79 39
Free Cash
Interest on
Secured Notes 18
Balance Sheet
Cash 3 5 15 2 35
Debt 497 512 371 234 234
* Excludes 10 million unrealized non cash foreign exchange loss on dollar-denominated senior secured notes in 2005 period.
The decline in sales in 2005 was due largely to the loss of two significant contracts with BT Global Solutions and Royal Bank of Scotland. The effect has been offset through new and expanded contracts with the British Council, U.K. Forestry Commission. The company has been able to reduce costs along with the decline in revenue. In the most recent 3rd quarter conference call, management stated that they believed GCUK fundamentals remained strong, that revenue will “level off” with revenue from announced contract wins offsetting the above mentioned losses and that the 3rd quarter is likely to represent the “low point” for GCUK’s revenues.
Overall you can see a trend toward declining costs and capital expenditures and debt and rising cash flow and cash.
Risks
The parent company, Global Crossing Ltd, is still a turnaround in progress. It has an enterprise value of approximately $1.1 billion with $736 million of debt (net debt of $476 after deducting current cash). Expected EBITDA loss in 2005 is in the range of $125 million. Management expects rapidly improving EBITDA and to become levered free cash flow break even by the 2nd half of 2006. While Global Crossing continues to be a hard turnaround, the company is supported by strong current shareholders including Singapore Technologies Telemedia (ST Telemedia) and Richard Rainwater. Global Crossing was written up on VIC by issambres839 in 2004 so readers can view that write up for more background on the parent’s business.
While the investment in GCUK’s Senior Secured Notes is separate from the parent company, and covenants exist to protect GCUK Note holders from the parent, there is a risk that if Global Crossing were to fail again it might harm GCUK’s ability to win new business.
The notes have a secured interest in the assets of GCUK with the exception of its leased fiber (which is 23% of total lit fiber), contracts with government or government suppliers, and the equipment supporting the provision of those government-related services, some of which is subject to existing leases. The notes are senior obligations and rank equal in right of payment with all of GCUK’s future senior debt. The notes rank senior in right of payment to all unsecured obligations or secured by liens that are junior to those securing the notes.
GCUK entered into a five year cross-currency interest rate swap transaction to minimize exposure of any dollar/British sterling currency fluctuations related to interest payments on the $200 million dollar denominated GCUK Notes.
Disclaimer: We own GCUK notes. We may buy or sell these notes at any time without notice. The information contained in this write-up is believed to be correct, but should not be relied upon. We undertake no obligation to update the write-up if new information arises at a future date.
Catalyst
Early 2006 tender for 14 -15 million British sterling of notes
Revenue stabilization and growth
Increasing cash flow leads to continuing and accelerated de-leveraging