Looming debt makes future of Xerox a question mark

Journal Record, The (Oklahoma City), Feb 19, 2001 by Riva D. Atlas N.Y. Times News Service

Xerox's stock has recently been popular with investors, but traders of its bank debt are a lot more skeptical about the company's prospects.

Xerox has a $7 billion bank loan that comes due in October 2002, which trades at close to 70 cents on the dollar. That is up from the low 60s just a week ago, according to Amroc Investments, a brokerage firm that specializes in bank loans. But the price is still worrisome, considering that, among loan traders, when debt trades below 80 cents on the dollar it is often a sign that a company will have trouble paying its debts.

Considering that banks get paid ahead of stockholders in the event of a bankruptcy filing, the market value of the bank debt bodes poorly for Xerox shareholders, according to traders in the loan market.

"The company's got a $5 billion market capitalization," said Kathy Brady, a distressed-securities analyst at Banc of America Securities.

"That's just not right."

To be sure, Xerox has taken steps to reassure investors since last fall, when it was forced to issue a statement countering rumors that a cash crunch would lead the company to file for bankruptcy protection.

The company disclosed that it had more than $1.7 billion in cash at the end of last year, and has also announced plans to raise $2 billion to $4 billion selling assets and another $1 billion cutting costs.

With investors no longer worried that Xerox is about to run out of money, the stock has nearly doubled from its low of $3.75 to $7.24 a share Thursday.

But until Xerox finds a way to pay off or refinance its bank debt, it will be difficult to assess the company's prospects, distressed- securities analysts and traders said. "There probably wouldn't be nearly the same number of questions confronting the business if it weren't for the bank debt," said one investor in distressed securities.

"This much debt coming due at once would be a problem for almost any company, except maybe General Electric or Microsoft," the investor said.

Xerox got itself into this predicament last fall, when, after a series of downgrades of the company's debt by the rating agencies, it became expensive for the company to raise short-term funds in the commercial paper market.

As a result, Xerox took advantage of its bank loan, which was meant merely as backup financing for its short-term debt. It is rare that companies actually tap these backup loans, according to loan traders.

Xerox probably will try to negotiate an extension or restructuring of the loan with its bankers next year. But bankers will want to see evidence that the company has made progress on its turnaround plan before they are willing to defer repayment of their debt.

Less than 1 percent of Xerox's bank debt has changed hands, according to traders.

The sheer size of the loan has been daunting: Most of the banks involved own $50 million to $375 million of the debt. Unless a vulture investor B someone who invests in troubled companies B is willing to buy a sizable piece of the loan, it is not worth it for a bank to sell, one investor explained.

Xerox's biggest lender is J.P. Morgan Chase, which originally committed to $750 million, according to documents filed with the Securities and Exchange Commission.

The bank's large exposure to the loan is a result of the merger of J.P. Morgan and the Chase Manhattan last month. (Each institution lent $375 million.) A spokeswoman for J.P. Morgan declined to comment, although executives in the loan market say the bank has hedges in place that have cut its exposure to the loan in half.

The uncertainty surrounding Xerox's bank loan is reflected in the cautious approach vulture investors are taking toward the company. With the company's bank debt difficult to buy, vulture investors are eyeing Xerox's bonds.

Among buyers of Xerox's debt are the $20 billion Franklin Mutual Series funds.

"We continue to look at the company, and there could be larger opportunities as we move forward," said Jeffrey Altman, who manages the funds' distressed-securities portfolio.

While Altman would not comment about which bonds the firm has been buying, many vulture investors said they were favoring debt coming due before the maturity of the bank loan in October 2002. There is approximately $3.5 billion in debt due over that period, according to Geoff Oltmans, a high-yield bond analyst at Lehman Brothers, although much of the trading centers on three note issues with just $850 million outstanding, traders said.

"I am confident that they can meet their obligations over the next 12 to 15 months," one investor said. "After that, I have no idea."

The wariness with which vulture investors approach Xerox's debt is reflected in the prices of its bonds: Debt maturing this year trades at close to 100 cents on the dollar, while securities maturing early in 2002 trade 15 points below that. Bonds maturing in 2003, after the bank loan comes due, are priced in the high 50s.

Often, vulture investors will hedge their purchases of debt by shorting a company's stock. But in this case, several vulture investors said they were afraid to bet against Xerox's shares. That is because there could be a short-term rise in the stock over the next few weeks, after Xerox's expected announcement of the sale of a 25 percent stake in Fuji Xerox, its joint venture with Fuji Photo Film.