Motorola's Iridium Tab Is Higher Than Expected

Motorola's (MOT) potential losses are even bigger than previously thought.

Motorola Wednesday said in a conference call that its close ties to troubled satellite phone provider Iridium (IRID) could cost it as much as $2.2 billion. That figure is even bigger than the $1 billion to $1.7 billion range from Alex Cena, an analyst with Salomon Smith Barney.

So after taking into account reserves of $800 million, Motorola could be forced to come up with another $1.3 to $1.4 billion if it were forced to make good on its legal obligations related to financing Iridium, of which it owns 18%.

Motorola also said that Iridium has three options: a restructuring, Chapter 11 bankruptcy protection and liquidation.

The following story was originally published on July 13 at 9:39 p.m. EDT.

In its second-quarter earnings release Tuesday, Motorola (MOT) said it will soon have a better idea of how much it will ultimately have to shell out to cover Iridium's (IRID) financial failings. But some analysts already are betting the number could be huge.

Alex Cena, an analyst with Salomon Smith Barney, says Motorola could lose $1 billion to $1.7 billion thanks to Iridium's continuing financial woes. (Solly hasn't performed underwriting for Motorola or Iridium.) After allowing for $800 million in reserves already, the financial hit would be $200 million to $900 million, depending on when Motorola had to recognize the losses. At a maximum, a loss of this magnitude could equal Motorola's earnings for a whole year.

But Motorola, which owns 18% of Iridium, said in its earnings release that "the previously announced sales of several businesses and assets are expected to generate significant gains and significant cash inflows in the third quarter, enabling Motorola to maintain a strong financial position, even with the negative impact of charges that may need to be absorbed by Motorola in the financial restructuring of Iridium LLC."

Still, the company said an Iridium restructuring could "necessitate an additional special charge" in the third quarter. It also noted that, in the second quarter, Motorola again deferred recognition of profits from its big operations and maintenance contract with Iridium. And it recorded a $126 million charge to write down the value of Iridium bonds.

Excluding charges, Motorola earned $273 million, or 44 cents a share, in the quarter, beating the First Call consensus of 41 cents a share and far better than the year-earlier's $6 million, or 1 cent a share.

Iridium's debt load is staggering -- totaling $3.5 billion -- which is forcing talk of a massive restructuring. It has $1.5 billion in high-yield debt outstanding; an interest payment is due on that debt July 15, with a 30-day grace period. It already is in danger of defaulting on financial covenants relating to an $800 million secured credit facility that is deferred until Aug.11. If Iridium defaults on that, then the company will also be considered in default of another $750 million credit line guaranteed by Motorola, not all of which has been utilized by Iridium. In addition, by Sept. 1 Iridium will owe approximately $470 million to Motorola: $400 on an operations-and-maintenance contract and $70 million previously owed to Motorola from Iridium.

Meanwhile, Iridium sits with slack demand for its satellite phones. Iridium was supposed to sign up 27,000 customers by March 31; it had only 10,294. It slashed prices July 1 by up to 68%, and its current subscriber base is estimated at 15,000 to 20,000. Iridium says it'll report new subscriber figures at month's end. One problem: Low-earth orbit satellite phones don't work well in buildings, a fact stated in the owners' manuals but which many impatient customers never read.

"Iridium, like others in the satellite industry, underestimated the time, energy and expense that have to be put toward the marketing, sales and distribution," says Ed Cornet, vice president of commercial space at Booz-Allen & Hamilton, which has done consulting for Iridium. "There is a belief in the industry that if you can do the rocket science of getting the satellites launched and working that you can do anything. Unfortunately, nobody makes any money until the systems are sold and used heavily."

Analyst John Bensche of Lehman Brothers believes Iridium will survive because it's in all parties' best interests for the satellite network to generate revenue. (Lehman hasn't performed underwriting for Iridium but has underwritten for competitor Globalstar Telecommunications (GSDRF).)

"In a sense, the creditors have a gun to their own heads," says Bensche. That's because a majority of the shareholders -- including Motorola -- are strategic partners of Iridium that own the licensing and gateways in other countries, says Bensche. "If the creditors alienate the gateways by trying to grab too much of the pie, they will be stuck with 66 satellites with no salvage value," he says.

Motorola also has profited from its relationship with Iridium. It already received $3.5 billion as prime contractor to build Iridium, which was finished in November 1998. Of course, Motorola hasn't recognized the profits from that contract, instead placing around $800 million into financial reserves, including $50 million in the first quarter, according to Cena at Solly. Motorola didn't specify whether it put aside more reserves for Iridium in the second quarter. If Iridium survives, Motorola could complete the five-year operations and maintenance contract, bringing combined total revenue from Iridium to around $6.7 billion.

One analyst thinks that Motorola's profitable contracts with Iridium may be partially responsible for Iridium's financial woes.

"Motorola is playing both sides of the equation here," says analyst William Kidd of C.E. Unterberg Towbin, a firm that hasn't underwritten for Motorola or Iridium. "The operations and maintenance contract is very profitable for Motorola and expensive for Iridium. They are charging $500 million per year for services that cost them between $150 and $200 million to provide." Motorola declined to comment on the issue.

The trick will be to convince bondholders to accept more equity in lieu of payment and convince the shareholders to accept a large dilution, says Kidd. "Afterwards, if Iridium goes bankrupt, dilution will occur to an even greater extent because Motorola will acquire a pseudo-equity position proportional to the debt. The resulting dilution will be huge."

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