Back to the Grind: Lucent Loan Customer Nears Collapse

A day after its escape plan went up in smoke, Lucent (LU Quote - Cramer on LU - Stock Picks) reminded investors why it needed help in the first place.

Australian phone service upstart One.tel said Wednesday it was talking with creditors after its funding collapsed, leaving it near bankruptcy. Lucent had previously agreed to provide up to $500 million in equipment financing to One.tel, which is 47% controlled by an investment team headed by News Corp.'s (NWS Quote - Cramer on NWS - Stock Picks) Rupert Murdoch. The amount of the loan that One.tel has actually drawn down wasn't disclosed, and Lucent didn't immediately return calls seeking comment.

But in the wake of the collapse of merger talks with Alcatel (ALA Quote - Cramer on ALA - Stock Picks), Lucent's loans to struggling telecom companies will draw renewed attention from investors. The company has been the most generous of the network equipment makers in extending loans, and as upstart network builders fail, problem credits will inevitably pile up, analysts say. These losses could further drain a company whose debt load and operating problems are already burdensome. Lucent fell 18 cents to $8.14 Wednesday.

Problems

"The market and the analysts think the worst is over, and I don't think that's true," says Cecilia Ricci, a finance professor at New Jersey's Montclair State University. "I think the worst is yet to come. There will be a lot more companies having problems, especially if we are heading for a worldwide slowdown."

In 1999, Lucent agreed to supply One.tel with $563 million worth of wireless infrastructure equipment. In winning the contract, Lucent promised to provide the Australian company with cash to buy gear to build out its network. Lucent bet that One.tel would become successful enough to repay the loan and, someday, order more gear. But the intervening years have shown that lots of small telecom companies never got that far.

Ricci and others point to the example of Winstar, a New York-based telecom network builder that last month filed for bankruptcy, leaving Lucent holding the bag to the tune of $500 million in bad loans. And it could have been worse, analysts note: Lucent had committed to lend Winstar up to $2 billion.

Banks Are Open Vendor financing commitments at Lucent, by year
(figures in millions of dollars)	2000	1999	1998	1997	1996	1995
Loan Commitments	$7,300	$7,118	$2,622	$1,898	$156	$16
Loans Drawn Down	1,800	1,574	536	25	7	13
Co-signed Loans	1,800	420	292	309	494	598
Co-signed Loans Drawn Down	740	312	205	118	346	296
Source: Securities and Exchange Commission filings

Winstar helped drag the so-called vendor-financing practice out into the daylight for all of Wall Street to see, observers say. Though the terms of these loans weren't usually disclosed, analysts and investors ignored the risks because all the equipment sellers were offering similar terms. Moreover, demand for communications equipment was growing so fast that gearmakers saw production shortfalls as practically their only worry.

But that all changed last year, when investors stopped speculatively funding telecom projects, driving telecom stocks and bonds through the floor and leaving capital-hungry network builders without money to complete their ambitious buildouts. Starved of cash, the network builders stopped spending, reducing sales at the network equipment makers that had offered so much to win their business. With sales growth threatening to fall short of targets, the gearmakers sought to lock up more sales with vendor-financing contracts, even as the economic slowdown made cash even more scarce for network builders. The loan party was under way.

Rearranging the Deck Chairs

"Winstar was just the tip of the iceberg," says Ricci, who tracks vendor financing. Lucent has been far from the only offender, observers note, adding that neither Cisco (CSCO Quote - Cramer on CSCO - Stock Picks) nor Nortel (NT Quote - Cramer on NT - Stock Picks) has been content to leave the banking to the bankers.

Now, like a bad cologne, Lucent's whopping $6.9 billion in outstanding loan commitments precedes it. Some observers even wonder how big a role this financing albatross may have played in the failure of the Alcatel merger negotiations. And investors have to consider the overhanging loans when they ponder putting money in Lucent even at $8.

"By buying Lucent, you are buying a portfolio of distressed debt in telecom service companies all across the board," says a New York-based hedge fund manager who has no position in Lucent.

That's not a pretty prospect, observers agree. "Lucent has given away a lot of money, and Lucent is really going to get hurt," Ricci says.