Perhaps the most puzzling situation amongst carriers right now is the behavior of XO, which BearOnBusiness described recently as ‘reckless’. XO has great assets – an IRU for 18 fibers on the original LVLT network, substantial metro assets connecting 3000 on-net buildings, and piles of LMDS and microwave spectrum. And yet, their stock is off 90% in the past year. That’s worse than Level 3, which had a simply horrible year as integration blunders decimated revenue growth, it may be the worst in the sector. And yet, XO is basically in the same position today that they were in last year, at least from a competitive standpoint – weak but holding steady. But XO’s common stock, it turns out, moves almost completely independently from its fundamental performance. What drives it? Carl Icahn.
XO is Icahn’s private garden, he owns most of the debt, most of the preferred stock, most of the warrants, and most of the common stock. Most if not all of the board of directors is affiliated with or even employed by him. XO’s senior debt, of which he holds some 94%, comes due next year and in their latest 10Q XO reports that he is not currently willing to extend it and the company exploring “alternative strategic alternatives” (what a wild expression that is!). What’s more, in the face of a lack of funding, XO is expanding its capex. That’s right, if XO can’t find external financing (and it publicly says it is having difficulty), then Icahn is threatening to accelerate his own train into a wall. And people wonder why no one wants to own this stock? Earlier this year, a minority shareholder went public about all this, and the response was simply a delay with an extra $75M from Icahn to hold the status quo. Where can this possibly play out?
The answer, I think, lies in the question “What does Carl Icahn want?”. In fact, when put this way there seems only one answer. He wants the NOLs, the net operating loss carryforwards, of which XO has several billion dollars on the books. The NOLs can be applied against future profits, thus reducing taxes for the owner. The laws are complex and usually it is difficult to transfer these assets in a useful form, but there are exceptions and this seems to be one of them. Usually, a buyer faces major restrictions on NOL usage based on the purchase price, but I believe those restrictions are triggered by an ownership threshold which Icahn is already above. Usually, the NOLs follow the assets and need to be used in the same industry – but Leucadia proved in its sale of WilTel to Level 3 that NOLs can in fact be separated from the assets if the transaction is structured properly.
But bankruptcy would be counterproductive, it would be long, tedious, and litigious. Viewed from afar it would seem that at some point in XO’s voluntary high speed approach of their debt wall, Icahn will throw minority shareholders a bone, and they will take it. He will then take full ownership, separate the NOLs, and sell off the pieces. Hard to say when or at what price though. Given that other than Icahn, XO’s entire management team and board of directors owns less common stock than it takes to buy a Toyota, I’m guessing they don’t know either.
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