Updated from 8:34 p.m. ET
shareholders' unhappiness with a recent financing from
Promethean Capital Group
, you'd think they were getting chained to a rock and having their livers eaten out on a daily basis.
But though the $100 million convertible note deal isn't quite the free-money type of financing that Internet companies were able to get in 1999, the widely held belief that the convertible bond deal will kill Excite@Home's equity may be just a myth.
Excite@Home's shares have fallen nearly 50% over the past two weeks, mostly in response to the Promethean deal. While part of that reaction is in response to the deal's possibly dilutive terms, it appears that most of it is in response to the reputation that Promethean has developed through previous financings and the perception that the terms are onerous for Excite@Home. That isn't so, the company and an analyst say.
Excite@Home's shares fell 30 cents Friday to close at $2. Shares closed at $3.92 the trading day before the June 11 announcement of the transaction. Battered by the perception that it will suffer from competition in the high-speed Internet access market, the company's shares are down more than 90% from their 52-week high of $23.
Promethean Capital, which arranged the financing, bears a reputation for lending money in transactions known by the unflattering name of "death spiral convertibles." In these transactions, borrowers agree to pay back loans in the form of stock, with the number of shares they hand over based on the shares' price in the market at the time the loan is repaid.
The hazard for the borrowers' shareholders is that in these transactions, there's no floor for the stock's value in the repayment. So if a borrower's stock starts falling, the company will have to issue more shares to repay the lender. Other shareholders, seeing the threat of dilution, will dump their stock. The dumping causes the share price to fall further, meaning that the company will have to issue more shares to the lender. This potentially endless loop leads to the "death spiral" name; companies that have seen their stock plummet after deals with Promethean -- though they certainly had troubles unrelated to their financings -- include the software firm
and the defunct online retailer
But Excite@Home Chief Financial Officer Mark McEachen says this deal is different. One crucial element of the deal, he says, is that if Promethean asks for the note to be paid off, it is solely Excite@Home's decision whether the loan will be repaid in cash, stock, or a combination of the two in a ratio to be determined by Excite@Home. "Usually,
the choice is at the investor's option," he says. "That's not the case here." Excite@Home also has the option of redeeming the five-year convertible notes on the second, third and fourth anniversaries of the deal, again in a form of its choosing.
Of course, decisions regarding how the note is repaid will depend in part on the company's access to money, a variable over which it doesn't have complete control. But the company raised a total of $185 million this month from the deal with Promethean and a separate transaction with
. McEachen says Excite@Home expects to have $175 million cash on hand, up to $20 million of which is restricted, by the end of June. The company is telling investors it will reach break-even on earnings before interest, taxes, depreciation and amortization in the third quarter, and that capital spending will diminish from levels in the first half of the year.
But in addition to their death-spiral fears, investors are concerned about the dilution the deal would create if Excite@Home's shares rose, because the note is convertible by the borrowers into nearly 23 million Excite@Home shares at any time they choose, at $4.38 per share. There are 322 million shares of Excite@Home's Series A shares outstanding; all of its Series B shares are held by controlling stockholder AT&T.
But McEachen says the dilution, if the note is converted, won't be as bad as people think, because it will be offset by the hoped-for dissolution of a distribution agreement with cable operator
. "It wasn't by coincidence that the number of shares
in the convertible deal is almost exactly the same as the number of share warrants we expect to get back from Cablevision," McEachen says.
Doug Shapiro, cable TV analyst at
Banc of America Securities
, says that though the deal could result in significant dilution under certain circumstances, it's not as bad as investors think it is. "Promethean has a reputation for structuring 'toxic' converts that continually reset the conversion price as the underlying stock declines," he wrote in a recent report. "However, the terms of this note are different." Shapiro has a buy on Excite@Home; his firm hasn't done recent underwriting for the company.
Another person who argues that the deal isn't as bad for Excite@Home as it looks is Jamie O'Brien, managing member of Promethean Capital. "I think people were, quite frankly, confused," he says, adding that investors were expecting to see toxic-convert provisions like those in
story mentioning Promethean. "They're just not here," says O'Brien.
The Excite@Home deal, with its fixed conversion price, has a "totally different structure" from the eToys transaction, which had a floating conversion price, says O'Brien. In fact, he says, the Excite@Home deal was more modeled after mainstream trends in convertible financing illustrated by recent issues from
. One of the primary differences between the Excite@Home deal and the Tyco transaction, he says, is that the $4.38 conversion price for Excite@Home shares reflects a conversion premium of only 10% above where the company was trading at the time the deal was set -- a relatively small premium that reflects the deal's credit risk, says O'Brien.
McEachen says he was aware that investors might be rattled by the headline news of the deal, so Excite@Home filed the deal's details with the
Securities and Exchange Commission
at the same time it issued a press release announcing the transaction. "We were very disappointed in the overreaction," he says.
But he continues to believe the company made the right decision to select the deal out of the more than a dozen financing proposals he says Excite@Home received. "If I had to do it all over again today, would I do the same deal?" McEachen asks. "Absolutely. Positively. I wouldn't hesitate."