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Classic Seeks Shelter

Classic Communications Inc., the Tyler, Texas-based MSO that has struggled for months to pay off bond debt and keep its customers from jumping ship, threw in the towel last week and filed for Chapter 11 bankruptcy protection in U.S. Bankruptcy Court for the District of Delaware.

At just under 350,000 subscribers, Classic is believed to be the biggest MSO ever to seek Chapter 11 protection. But it is the second MSO to make such a filing in a month, following Galaxy Telecom LP on Oct. 31.

Classic's filing is the type of bankruptcy designed to help a company wipe out some debts, pay other obligations and remain in business with new funding. The MSO obtained a commitment for $30 million in debtor-in-possession financing from Goldman Sachs Credit Partners LP to help fund operations while the company reorganizes.

The proceeding was needed "to rectify operational and liquidity difficulties resulting from increased competition and the service of high-cost debt," Classic president Dale Bennett said in a statement.

Classic plans to "emerge quickly from bankruptcy with a strong regional presence in its core markets of operation," Bennett said.

The MSO said it will continue operating as usual and that the bankruptcy would not affect customers.

While it is possible that Classic will get back on its feet, other industry observers say that will be a difficult task, especially in today's economy.

"It gives them some liquidity with which to pay their day-to-day expenses," said Moody's Investors Service senior vice president Russell Solomon. "It's a short-term fix, in advance of what I imagine is a pre-negotiated restructuring agreement."

Some observers believe a likely outcome for the MSO involves either a liquidation or a transfer of control to bondholders, to whom Classic owes $378 million.

That latter scenario would be similar to what happened to Sikeston, Mo.-based Galaxy, which has about 125,000 subscribers. Galaxy, which like Classic had struggled to meet its high-yield debt obligations, agreed in October to swap its debt with its major bondholder, Romulus Holdings inc., for 92 percent of equity.

Romulus, a New Rochelle, N.Y., investment firm that specializes in "distressed" companies, was also rumored earlier this year to have bought some of Classic's debt at rock-bottom prices. Sources said the plan is to combine the assets of Galaxy, and possibly Classic, with another Romulus holding — direct-to-home satellite service provider WSNet Inc. — thus enlarging the DTH service.

Classic officials did not return calls for comment.

"I think it goes through the whole process" to liquidation, predicted David Unger, managing director of Avalon Equity Partners, a New York City private-equity firm that invests in small cable systems. "I think they overpaid [for their systems].

"There are good subscribers and bad subscribers. There's a big dichotomy between Long Island and Northern New Jersey and little [rural] systems," Unger said. "I don't think Brera [Capital Partners, Classic's largest shareholder] or Classic understood the dichotomy."

Communications Equity Associates senior vice president Brian Sweeney said Classic should attract its fair share of interested buyers for at least some of its systems.

"They have a good group of systems together," Sweeney said. "There will definitely be a lot of interest from a lot of different circles."

Classic started its life as a public company on a high note: It raised $180 million in a December 1999 initial public offering. It went public at a robust $25 per share, and the stock quickly rose to $39.

But the bottom later dropped out, and Classic languished in the $5 range for much of 2000.

This past April — after the company revamped management and investors saw that efforts to offer new services and focus on larger systems weren't working — the stock fell below $1. It has languished at around 14 cents per share since early September.

The NASDAQ stock exchange halted trading in Classic last Tuesday — the day of the bankruptcy filing — and has requested more information from the company. Prior to the halt, Classic was trading at 13 cents.

DIFFICULT SYSTEMS

Several industry observers said the MSO's problems were, indeed, classic. Although it focused on smaller markets, Classic had a knack for buying systems that were spread too far apart and needed substantial investment for upgrades. At last count, the company had 576 headends, some supporting as few as 200 subscribers. The ideal for rural systems is about 15,000 customers per headend, experts say.

Although it had a partner in Brera — the New York-based private equity firm that pumped in $100 million shortly after the IPO in exchange for 64 percent of equity interest — that money mainly went to finance prior acquisitions.

As the stock began to drop, Classic couldn't use equity as a deal currency, and capital markets — which were supposed to help fund upgrades — began to dry up as subscribers switched to direct-broadcast satellite.

"There were a lot of good ideas behind Classic, but the capital structure was always too thin to bring those systems to the next level," Sweeney said.

That became evident in August, when Classic said in its quarterly report that it had not made interest payments on its credit facility since June 30 and was prohibited from making interest payments on its bonds.

Negotiations broke off for a $75 million loan package that would have put Classic back on its feet, at least for a while. The MSO hired Credit Suisse First Boston as a financial adviser to look at alternatives, including bankruptcy protection.

In September, Classic defaulted on a $7.2 million interest payment, and said that unless it could restructure its debt, it would likely file under Chapter 11 of bankruptcy law.

Classic has been around since 1992, when it was formed by attorney-turned-entrepreneur Merritt Belisle. The former Classic CEO modeled his company on TCA Cable TV Inc., another Texas-based small-market MSO that, at the time, was the only operator to report earnings per share and pay a dividend.

But about a year after Classic's IPO, the deal market dried up along with the capital markets, and Brera decided it was time for a change. Belisle and other top managers, including CFO Steven Seach, left toward the end of last year.

In their place came a team more skewed toward operations than acquisitions. Bennett, Classic's former chief operating officer, had run AT&T Broadband's Dallas region. Also coming on board were former Prime Cable Partners Inc. chief technology officer Dan Pike and former TCA Cable CFO Jimmie Taylor.

Bennett and his team switched the company's focus to upgrading larger core systems and bringing in new services, including digital cable. But it may have been too late.

Cash-flow growth ground to a halt as customers switched to DBS. Cash flow rose just 0.7 percent in 1999, to $185.5 million, and declined by 5.4 percent in 2000.

In 2001's second quarter — the latest period for which results are available — cash flow had declined 11.8 percent on a year-over-year basis.

Between February 2000 and September 2001, Classic lost 67,000 customers. A plan to sell off about 48,000 subscribers in smaller markets never attracted the right buyers.