Xerox falls, bounces on accounting disclosures; three downsized deals price

By Paul Deckelman and Paul A. Harris

New York, June 28 - When Xerox Corp. announced Friday that it would restate $6.4 billion in revenues from 1997 to 2001 - including $1.9 billion of expected future revenues that were improperly booked as current in those years - bondholders smacked their foreheads in disbelief and dismay over the latest major corporation accounting problem and braced themselves for a massive plunge. But while the bonds fell sharply initially, they had bounced off their lows by the end of the day to come most of the way back on the realization that the problem doesn't really affect the troubled copier king's debt.

In primary market activity, Dave & Busters, Plains Exploration & Production Co. and LBI Media Inc. each came to market with new issues - but reflecting the suddenly cautious tone in the junk market following the meltdown of WorldCom Inc. debt earlier in the week and the continued regulatory problems of a number of prominent junk names, the issues emerged downsized from originally proposed amounts.

And the three were all that were reported completed out of the six transactions anticipated for the session.

With all three reduced in size and wide of price talk, issues of corporate malfeasance that are said to be corroding investor confidence throughout the capital markets cannot fail to bear on high yield. That was the verdict of the sell-side sources who spoke Friday with Prospect News.

"My buddies are telling me that everyone and their mothers are going to the hedge fund business," one official said

"I feel like people are sitting there shorting everything. There's a huge amount of pressure in the equity markets. You have a lot of companies whose equity value has gone to zilch...some major high yield issuers that don't have any cushion left."

Another official, when asked for evidence that the gargantuan book-cooking that has been alleged to have taken place at WorldCom, Inc. and Xerox Corp. would impact high yield, gave a nod to the $158 million outflow from high-yield mutual funds for the week ending July 26, as reported by AMG Data Services.

When Prospect News objected that the data in question were compiled prior to the breaking of the WorldCom debacle, the sell-side source retorted "Yes, but WorldCom is just the latest.

"It's just another story," the source continued, alluding to previous corporate scandals involving Enron and Adelphia Communications.

"WorldCom's one of the biggest ones but it's just another story."

All three deals that priced Friday were downsized, and all came wide of price talk.

Los Angeles-based Hispanic broadcast company LBI Media reduced its deal to $150 million from $200 million and priced the 10-year senior subordinated notes (B3/B-) at par to yield 10 1/8% via joint bookrunners Credit Suisse First Boston and UBS Warburg. Price talk had been for a yield in the 9% area.

Dave & Busters' deal, sold through D&B Acquisition Sub, Inc., was cut to $155 million from $165 million. The seven-year senior secured notes (B2/B) priced at 96.620 to yield 13% via joint bookrunners UBS Warburg and Deutsche Bank Securities Inc. Price talk was 12¼%-12½%.

Finally, in the wake of oil and gas exploration and production companies that priced junk bonds with seven- and eight-handles throughout the spring, Plains Exploration & Production came with an offering of $250 million 10-year senior subordinated notes (B2/B). It was downsized by $50 million and priced at 98.376 to yield 9%, wide of the 8½%-8¾% price talk, via joint bookrunners JP Morgan and Goldman Sachs & Co.

And although terms were expected Friday on Gristede's Foods, Inc. $175 of million of 10-year senior notes (B2/B+), Solutia Inc./SOI Funding Corp.'s $250 million of seven-year senior secured notes (Ba2/BB-) and Workflow Management, Inc.'s $170 million of seven-year senior secured notes (B2/B+), Prospect News learned from syndicate sources that those transactions are now expected to price on Monday.

Taking a look at Friday's results one source from the sell-side said : "This is going to scare some primary market activity off a little bit.

"Investors are getting whacked in the secondary right now and that's really hanging heavy on their confidence and their desire to do deals," the official continued.

"I think the volume is going to slow down a little bit. You don't see a lot of people rushing into this market."

In fact no new offerings emerged during the last three days of the week of June 24. However this official conceded that the slowness can, to a greater or lesser extent, be attributed to the Independence Day holiday that will abbreviate the week of July 1.

Finally Friday terms emerged on the high-grade deal from Aquila, Inc. The Kansas City, Mo.-based energy company priced $500 million of 10-year senior unsecured notes (Baa3/BBB) at 440 basis points over Treasuries.

In dollar terms, Aquila's notes priced at 99.255 to yield 11%. Bookrunners were Credit Suisse First Boston and UBS Warburg.

An informed source told Prospect News earlier that the Aquila deal would essentially be high yield, as the energy trader had come to the bond market having announced job cuts and other actions to circle the wagons, following its lowered predicted operating earnings for 2002.

"They had terrible timing," this informed source said in the wake of Friday's transaction. "Whenever you go out to the market in desperation they're going to take it out of your hide."

Back among the already established names, it looked as Xerox would emerge as the disaster of the day, when the Stamford, Conn.-based copier and office machines giant said that it would be re-stating $6.4 billion of revenues booked over the past four years - a larger restatement than even the $3.8 billion of expenses which WorldCom said it would have to restate.

Xerox said that about $5.1 billion of the $6.4 billion of revenues previously recorded as having come from equipment sales, will now be reported instead as service, rental, document outsourcing, and financing revenues for that four-year period. Additionally, the company said that the $1.9 billion of anticipated future revenues that was recognized over past years will now be recognized in the future, beginning with this year.

Coming as it did on the heels of WorldCom's stunning announcement late Tuesday that it had improperly booked as much as $3.8 billion of operating expenses as capital expenditures - thus artificially pumping up its bottom line and EBITDA cash-flow totals for 2001 and early 2002, the continued regulatory scrutiny of companies such as Qwest Communications International Inc. and the long-awaited bankruptcy filing late Tuesday of Adelphia Communications Corp. - also bedeviled by accounting issues related to its previously hidden transactions with its former controlling family - the Xerox announcement seemed like the latest in a growing line of accounting fiascos that have battered the confidence of high yield investors and equity players alike.

Xerox's shares and bonds plunged in the early going. A trader saw "quite a bit of activity" in Xerox's bonds on the downside, opening down about 20 points from Thursday's closing levels.

He saw the most active issue, the 5½% notes due 2003, and the 9¾% notes due 2009, starting the day off at around 70 bid, well down from Thursday's finish around 91 bid/92 offered. But then the bonds "came back throughout the morning and came back pretty close to where they had been." He saw the 5½% notes ending in the 86-88 area while the 9¾% notes, after having firmed off their early lows to as high as 86 bid, ended in the 83-85 area. "There was a real shock first thing in the morning, then they came bouncing right back."

High yield analyst George Kirchwey of SAMCO Capital Markets in New York opined that the news that Xerox may have improperly booked several billion dollars in revenue over the last several years "does not much affect our view of Xerox from a bondholder's point of view."

He said that the accounting discrepancy - which involved how the company should recognize revenue from long-term equipment leases - and the restatements of that income "should not materially affect the cash coming in from customers paying every month on their lease contracts, which in our view is what backs up the near-term Xerox bonds."

Kirchwey said that SAMCO continues to see Xerox's short-maturity bonds - those coming due in the next 24 to 30 months - as being "fairly well secured by these cash flows coming in from the existing equipment lease portfolios." Longer-term, however, he said that both Xerox's bonds and the venerable company's very future are "real question marks. The longer-maturity Xerox bonds will have to be repaid by cash from ongoing operations, not just cash coming in from the lease portfolio, and that's where we see the real weakness."

The SAMCO analyst acknowledged the role that market psychology seemed to be playing in at least the initial retreat on both the stock and bond side, noting that "market sensibilities are unusually tender now, especially after the WorldCom accounting debacle, and the Xerox news could not come at a worse time."

But Kirchwey said that his shop's view was that "to some extent, this accounting topic is old news for Xerox." He said that the recent price drop in some of the copier king's bonds "may create a buying opportunity for investors who can see through the current headlines to the actual sources of repayment."

He reiterated that "if you are following the short bonds that are being paid by the cash coming in off the lease portfolios, that cash, that cash flow should not be interrupted or changed materially by the accounting high jinks going on there."

Kirchwey said that the initial Xerox news seemed to have its biggest impact in early-morning (U.S. time) trading in Europe. "The bonds opened down 12 to 14 points in Europe, and I think the Europeans rightly have some concerns with what's going on with these American companies."

However, once trading got underway in the States - and once bond investors realized that this was more of a problem on the stock side than on the debt side, "Xerox recovered in the U.S. markets quite nicely, as people realized that at least in the short run and from the bond point of view, this is really kind of old news for Xerox, and it's a question of revenue recognition, not cash flow.

"If you're an equity investor - and we are not - I think you really have to look at earnings per share for the last few years with a completely different set of magnifying glasses. They apparently elected to book the revenue much more in the front end instead of spreading it out, which I think was the gist of their disagreement with the Securities and Exchange Commission. For equity investors this is troubling [Wall Street agreed; the shares plummeted $1.03 (12.88%) in New York Stock Exchange trading Friday to

$6.97 on volume of 48 million shares, almost ten times normal] But for the bondholders, this is not a material change."

The trader meantime agreed that such an analysis "definitely makes sense. You could kind of see that a lot of the [early] selling was retail stuff, a lot of small pieces, while any institutional players that were involved, the larger trades, were mostly buyers."

He said that clearly, what had happened was an initial panic reaction by bondholders fearing the latest in a long string of junk market accounting debacles. "They read the headline in the Journal and just got really scared. The mom-and-pop [small retail accounts] just wanted to get out. People threw those low 70-ish bids out there in the morning, and a few people got lucky and bought stuff down there. Then it bounced right back. "

Elsewhere, another trader said, WorldCom was active in the morning, "but then kind of slowed, and took a breather." He saw telecom and other communications issues remaining "weak, but not much weaker than it's been, whether it's Nextel [Communications Inc.] or Charter [Communications Holdings]. There was no real trading, no real down trading. I think they kind of got out of the way." He quoted Charter's bonds - which had been steadily knocked down into the 60s from previous levels in the high 70s on investor jitters about the cable sector arising from the Adelphia bankruptcy - as remaining in the 64-66, or 65-68 levels. "There was no heavy trading" in the St. Louis-based cabler's paper. At another desk, Charter's 8 5/8% notes due 2009 had improved two points, to 66 bid, while its 9.92% notes due 2011 were a point better at 48.

Adelphia's 9 7/8% notes due 2007 were quoted down nearly two points at 39.5 bid, while its Century Communications Inc. 8 7/8% notes due 2007 were seen three points lower, at 29.

WorldCom's bonds "came back a little," a market source said, quoting the beleaguered Clinton, Miss.-based telecom giant's 7½% notes due 2011 at 15 bid/16 offered and its 6 ¼% notes due 2003 nearly two points up at 16.5. The company's MCI unit's bonds were a point higher across the board, its 8¼% notes due 2023 ending at 26, while its Intermedia Communications Inc. subsidiary's zero-coupon notes moved up to 32 bid from 30.5 on Thursday.

Outside of the communications sphere, Magellan Health Services Inc.'s 9% notes due 2008 were being quoted as low as 39 bid, at least 10 points below levels they had held earlier in the week, despite an apparent lack of fresh negative news on the Columbia, Md.-based healthcare company, whose ratings were cut a notch earlier in the week by Standard & Poor's, which cited declining operating performance, high leverage and problematical liquidity.

A trader saw Calpine Corp.'s bonds hanging in around the 67-69 bid area across the board, down from prior levels in the mid-70s.

And he saw little immediate response to Friday's news that S&P had downgraded debt ratings for several airlines. "There wasn't much activity. Two or three days ago, you couldn't find bids on a lot of the stuff you had and I don't see much changed.

"To get a handle on where the bid side is going to be on this paper, I think, is going to take another couple of days, until people get involved again."

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