Those who thought Tevel¿s only problem was its huge bank debt, regulatory hurdles or the high price of content, found out in the past few months that the company has one more problem, no less life-threatening.
Discount Investments is playing it close to the chest and United Pan-European Communications (Nasdaq:UPCOY, ASE:UPC) isn¿t talking but there appears to be no doubt. The Tevel partners are embroiled in a serious dispute that could end in receivership for the cable company.
The story is fairly simply. Tevel desperately needs more loans from the banks to finance the next two years of losses and capital investments. The banks flavor of the month has changed recently and they are not willing to increase credit to the company without shareholders shouldering some of the risk ¿ cash or guarantees.
While Discount Investments sees its 48% of Tevel as one of its most important investments, Dutch company UPC has a whole different outlook on its 46.5%. The Dutch company itself faces bankruptcy and has no intention of injecting cash into Tevel.
In a normal situation, the partner willing to inject capital dilutes the partner who cannot or will not come up with the cash. However, when the value of a company drops dramatically, the ¿fine¿ paid by the non-paying partner is large: the stake is diluted to bare bones, even down to zero.
That is pretty much the situation in Tevel. The collapse f the telecom market along with a series of managerial goofs led by the acquisition of Golden Channels shares, have lowered Tevel¿s value to less than $100 million in the best case scenario, and zero in the worst case.
Logic dictates that Discount Investments, willing to inject tens of millions of dollars in cash or guarantees, will now dilute UPC drastically if not to nothing.
But reality is more complicated. What has been happening for the past year in companies here and abroad is that the rate of dilution is determined not by company value or the sum needed, but by the relative weight of the partners¿ threats.
Sometimes, the partner injecting the money dilutes the non-paying partner down to zero - known in professional jargon as ¿pay to play¿ or ¿wash out¿ - if you want to ¿play¿, put down the money, if you don¿t want to play ¿ you lose your stake or any money you have put down to date.
And there is the opposite situation in which the non-paying partner manages to ¿extort¿ good terms from the one who continues to invest. An this is apparently what UPC is trying to do: not inject any money into Tevel and not lose its stake.
The interesting question is why UPC thinks it can make such a brazen demand of Tevel ¿ not invest and still keep its stake more or less intact?
A senior UPC executive we met recently suggested a direction of thought. ¿IF we had control of Tevel, we would come to the banks and say ¿Get ready for a haircut¿, in other words, inform them they have two options: either they erase a large portion of the company¿s debt or we transfer managing the company to them. It¿s a fair bet they will prefer to write off debt and not get stuck today with a cable television company.¿
Ans that is exactly what UPC told its shareholders and creditors on European bourses. It offered an aggressive ¿haircut¿. ¿Write off 90% or more of the debt or your rights if you want the company to recuperate and your securities to ever be worth anything.¿
In other words, UPC thinks if Discount Investments threatened the Israeli banks that Tevel will declare bankruptcy ¿ then the banks will fold and grant more credit ¿ so UPC and Discount Investments won¿t have to inject more capital.
It is not clear that that is the case, but it is clear that Discount Investments can¿t make that kind of threat to the Israeli banks, at least not officially. Discount Investments is an investment company belonging to one of the largest concerns in the Israeli economy, where the two largest banks control 70% of the credit market. Discount Investments can¿t afford to ¿go whole hog¿ and threaten the banks that if they don¿t give up the debt ¿ Tevel will declare bankruptcy.
The same is true of Golden Channels and Matav Cable Systems Media (Nasdaq: MATV), the two cable companies about to merge with Tevel. Eliezer Fishman and the Dankner family would be happy to tell the banks they have no plans to inject money into the cable companies or that the banks must wipe out some of their debt, because otherwise the companies will go broke. However, but they can make no such threat since all the rest of their Israeli business is dependent on the banks¿ good graces.
Dilution battles are the daily bread of the technology and venture capital sector, in which most of the companies are desperate for cash and their valuations have imploded. The sector has been rife for the past year with vicious dilution battles in dozens of startups per month.
In most cases, the victor is the investor willing to inject money, but there are usually more losers than winners. Sometimes the real loser is the company that closes when no side is willing to cave in.
But in the next few months, the battle field will widen beyond just startups ¿ to the communications sector and basically to any company that needs shareholder support to survive. Dilution battles in cable television, in satellite, in cellular ¿ in every sector the partners will face off and show their teeth, with the banks in the middle in most cases.
Those who lose the dilution battles may leave the arena or sector never to return. Those who are good at the game will survive the tough times and hit the next boom with huge pieces of companies and sectors that are crashing now but will grow again in the future.