Moody’s sees risk to 700 MHz band manager Pegasus
Almost forgotten, but not gone, are two of the three companies that bought substantial chunks of 700 MHz Guard Band spectrum as “band managers” with the choice to use just less than half of it for themselves and to lease as much of it as they want to others. The three are Access Spectrum, Pegasus Communications and Nextel Communications.
Access Spectrum, Bethesda, Md., has publicized its leasing plans and is making 700 MHz spectrum available. It contracted Motorola, a part owner, to develop two-way radio products. The manufacturer’s 700 MHz products have received FCC type acceptance, and Motorola expects to sell production units this year.
Nextel Communications, McLean, Va., wants to use its 700 MHz spectrum as trading stock and has announced no plans to use its Guard Band spectrum for communications or to lease it to others. To see a related story about Nextel’s Guard Band spectrum, click here.
The third band manager with a large piece of Guard Band spectrum, Pegasus Communications, Bala Cynwyd, Penn., appears to have enough money trouble that it may be unable to devote the necessary resources to establish a spectrum leasing operation. Pegasus never has articulated a strategy for deploying the spectrum it bought, and company representatives do not return calls on the subject. Moody’s Investors Service has lowered the ratings for the debt and preferred stock instruments of Pegasus Communications’ subsidiaries, including Pegasus Satellite Communications and Pegasus Media & Communications, stating that the rating outlook continues to be negative.
The downgrades reflect Moody’s concerns about the company’s ability to continue operating under its current capital structure; the agency’s belief that a restructuring will most likely be needed; and that loss severity will be greater than originally anticipated under its revised expectations. Moody’s noted that Pegasus has underperformed relative to both original and revised management projections over the last two quarters.
When the outlook was revised to negative back in December 2001, Moody’s specifically cited the risks posed by the proposed EchoStar-Hughes merger as potentially disrupting if not jeopardizing Pegasus’ future business prospects or viability or both.
Moody’s reminded investors that “those risks and uncertainties remain subject to regulatory and judicial review, and are still very evident. Additionally, the proposed refinancing transaction failed to get completed as anticipated, leaving the stub PM&C notes outstanding and resulting in a reduced boost to the company’s liquidity profile. Although these were not deemed to be that significant at the time, the company’s recent term loan placement and security repurchases, specifically that for the preferred and common stock, in conjunction with the perceived plateauing of the company’s business growth prospects, have caused Moody’s to significantly alter its view of the underlying credit profile,” the debt rating company stated.
Moody’s said that recent actions taken by Pegasus’ managers suggest their own recognition that the company will be unable to grow into its balance sheet and ultimately service its substantial debt burden. At the same time, however, Moody’s questioned the appropriateness of redeeming junior (some very junior) instruments with senior debt, particularly at a time when capital preservation is so important to the company.
“Additionally, we are somewhat troubled by the partial PM&C notes redemption from an ‘unaffiliated holder’ at par value when the company’s securities are broadly trading at very distressed values. We also note the unusual money flow of late between Pegasus and PSC, and are concerned that the rated entity PSC’s balance sheet now reflects a large note payable and premium interest payments to Pegasus, even though substantial monies in excess of the payable amount even were recently reverted from the former to the latter,” Moody’s statement reads.
Moody’s said that Pegasus’ attempts to grow cash flow by curtailing marketing expenditures and improving credit screening measures have been admirable, but it said it believes that Pegasus’ competitive environment will continue to dictate the requisite spending levels by the company, and that all-in subscriber acquisition costs have grown and remain too high for the company to support over an extended time period. Further, the cost to merely replace subscriber churn, to retain subscribers or both is significant enough by itself to consume a meaningful amount of the company’s EBITDA such that little remains for debt service requirements, particularly after interest expenses are paid and even under the reduced interest burden on a proforma basis for the recent debt repurchases.
Despite the gloomy description, Moody’s said that its revised debt ratings for Pegasus do not necessarily assume a worst-case scenario. Although Moody’s said its rating carries the distinct implication that all of the company’s obligations are unlikely to be covered in a default, there is clearly some value in the company’s still large subscriber base, even after meaningful revisions during the first quarter and further reductions of a lesser scale as anticipated over the coming periods.
Additionally, Moody’s continues to note the comparatively weaker competitive profile of incumbent cable operators in many of the company’s rural markets, particularly relative to more suburban and urban cable operators. It remains unlikely in the rating agency’s estimation, though, that the company could arrange sufficient financing to support a “go it alone” strategy, and Moody’s continues to believe that a scarcity of potential buyers exist under either present or anticipated future market conditions.
As a result, Moody’s looks to the cash flow generating ability of the company’s assets in relation to the debt service and other capital requirements of the business in evaluating its creditworthiness. Given this, coupled with the almost entirely intangible nature of the company’s assets and the current capital structure, the loss severity to be expected in the event of a default could become much more extensive, particularly as more senior claims come into the capital mix at the expense of the more junior holding company claims, which will likely suffer much more disproportionately.
The negative outlook assigned by Moody’s primarily reflects continued uncertainty about the effect of the proposed EchoStar-Hughes merger and associated uncertainty about the status of litigation with DirecTV and the future relationship with DirecTV; the likelihood of further subscriber erosion and high costs to maintain current subscription levels as anticipated; and concerns about liquidity and the company’s capital structure in light of recent transactions undertaken by management.
Pegasus Satellite Communications is the largest independent distributor of DirecTV direct broadcast satellite pay television services, with programming distribution rights covering approximately 7.5 million homes and 1.372 million active subscribers in predominantly rural markets.