Big Deal - Rhythms Issues Junk Bonds

Posted 04/2000

Rhythms Issues Junk Bonds
By Ken Branson

For the third time in its short life, Rhythms NetConnections Inc. (www.rhythms.net) has gone to the high-yield debt market. This time, Rhythms has sold $300 million in 10-year debt at 14 percent. This trip to the junk bond yard comes in the wake of similar sorties by the other two national DSL carriers, Covad Communications Co. (www.covad.com), which sold $425 million for 10 years at 12 percent in January, and NorthPoint Communications Inc. (www.northpoint.net), which sold $400 million for 12 7/8 percent in early February.

"In general, high-yield investors recognize, as the stock market does, that data and Internet services will be the primary growth drivers for the telecommnications industry and that high-speed local connectivity remains the bottleneck to advanced communications networks being built by all the emerging providers," says Trent Spiridellis, vice president and senior telecommunications analyst at Banc of America Securities LLC (www.bofasecurities.com).

Spiridellis says Rhythms, Covad and NorthPoint have a year to 18 months in which to uncork that bottle for small and medium-sized business customers. Their principal competitors, the RBOCs, are "playing defense" for now, he says.

"People look at the DSL story and they're thrilled with the industry prospects," says Todd Morgan, senior high-yield research analyst at Credit Suisse First Boston (www.csfb.com). "The demand side seems extremely high; the value proposition it offers businesses and consumers, it's a great story."

On the other hand, Morgan, whose company was one of the underwriters on the Rhythms deal, also sees some bumps in the road. Fourteen percent was on the high side, he thinks, and he says there are covenants in the Rhythms bond giving the company less freedom for financial maneuvering than was the case for either Covad or NorthPoint. Rhythms CFO Scott Chandler denies this, and says the price was exactly what he expected, and exactly what he led his board to expect.

Morgan believes some junk bond buyers may be concerned about the huge difference in the numbers of DSLs the three companies expect to have installed by the end of this year. He projects 300,000 for Covad, up from 56,000; 155,000 for NorthPoint, up from 23,000; and only 56,000 for Rhythms, which now has about 12,500 lines installed. He accounts for the difference by pointing out the differing business plans of the three carriers. Covad and NorthPoint, he says, are wholesalers, keenly focused on metrics. Rhythms does direct distribution, hoping to make more profit with fewer lines by bundling lots of services for large corporate customers.

In any case, all three companies have used other means of raising money when appropriate. Just before its most recent high-yield offering, Rhythms secured $250 million in equity funding from Hicks Muse Tate & Furst Inc., the leveraged buyout firm. Spiridellis thinks this probably helped Rhythms raise its latest $300 million; Morgan isn't so sure. For Chandler, equity and debt are the yin and yang of his professional existence, and one tends to follow the other.

"We have tended to [go to the high-yield market] historically, after we've gotten some equity injected in the company," Chandler says. "The first time was May 1998, right after I came on board here. We'd just gotten two rounds, and then went to the public debt market. We then did our IPO last April, and went to the public debt market immediately after that. And then we just got $250 million in equity a few weeks ago from Hicks Muse."

Rhythms also recently obtained $75 million in lease financing with GATX Capital Corp. (www.gatxcap.com) and Cisco Systems Inc. (www.cisco.com). Between them, including the latest transaction, the two companies have poured $200 million into Rhythms' corporate tank in the past two years. With the lease financing, the Hicks Muse investment and the new debt, Chandler believes Rhythms has enough cash to fund its plan through the first quarter of 2001.

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