Gilat's winners and losers

According to rumors making the rounds, Gilat Satellite Networks (Nasdaq:GILTF) ( GILTF) is making moves to handle its staggering debt burden. The company plays coy with reporters, but it has no choice but to examine its options. D-day for payment, mid-September, is approaching like a freight train.

As of the end of the first quarter, the company's balance sheet bore debt of $350 million to holders of bonds issued in March 2000, when the skies were sunny and the mood merry. Money could be raised at a phone call and Gilat also tapped into the banks.

A year and a half later, the skies are threateningly black and Gilat is the proud owner of $484 million worth of debt.

Just servicing it costs the company $5 million per quarter. For a company posting an operating loss of $6 million per quarter, before financing costs, it is a mission impossible. It may even have to declare bankruptcy unless it reorganizes its debt burden, finger-wag some pundits.

One solution, heartily touted by shareholders, would be to convert the debt into shares. The logic is that it's better to own a piece of a company that may recover, than to weep over spilled milk. If the company survives, one day the new owners could get dividends, or sell their shares.

That would seem to be the direction Gilat is going. But there are no free lunches: where there are winners, there are also losers. Would converting their bonds into shares be the best option to stay in the W column? No.

Gilat today is controlled by its management and founder, Yoel Gat; Tel Aviv-based Discount Investment Corporation (TASE:DISI); and a few American investment funds. They will find themselves massively diluted, but even if all the bonds are converted into shares, they will probably retain control.

They could even shore up their control by allocating options to the management. That way the management, for all that it guided the company straight to the abyss, can stay at the helm. Yes, they will lose a hefty chunk of their share in the company, but they can still retain the power. They are the lesser losers from the move.

Then there are the banks. Gilat owes them rather less - $134 million. If an arrangement is reached with bond-holders, who will then get off Gilat's back their chances of getting their money back improve. Therefore, the banks will be winners from any arrangement with bond-holders.

So who'd be the big loser of conversion?

The bond-holders, that's who.

They originally bought assured commitments, not a share in gauzy future dividends, which is what investors in shares are buying.

Yes, a share in hand is better than a pile of rubble. But they have another option, which has better chances of restoring their investment.

That would be: Hang onto those bonds and allow Gilat to defer repayment.

Gilat's management evidently believes that without that hump on its back, it could return to the black. If bond-holders buy that, they should let it postpone the payment date of the coupon and interest for a few years. Despite Gilat's pitiful condition, and that of the telecommunications industry in general the company is still technologically and functionally a leader in its field.

The management, and many analysts covering the company, assume that if the debt is put aside - Gilat could make money again.

In case of liquidation, bond-holders get precedence over shareholders. If they decide to convert their bonds into shares, they will essentially be waiving that precedence. Any profits Gilat would register in that case would go to all stockholders equally, with nobody getting preferential treatment.

But if the bond-holders decide instead to defer payment of the interest and principal, the day Gilat gets back to its feet it will have to pay them first, before registering profit for shareholders. Thus, armed with patience and faith, the bond-holders will retain their status and rights.

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