Moody's Slashes RCN

Moody's Investors Service downgraded RCN Corp.'s debt rating last week, claiming that the Princeton, N.J.-based overbuilder is running out of options to raise cash to service its debt.

Last Monday, Moody's dropped RCN's senior debt ratings to Caa from Caa2 and its bank debt ratings to Caa3 from Caa1, after RCN said it would initiate a tender offer for $290 million of its senior notes.

According to Moody's, the tender offer — through which RCN would pay bondholders between 32 cents and 37 cents on the dollar for their bonds — is the third "distressed exchange" by the company in a little more than two years and indicates that RCN is in dire need of a restructuring.

Moody's: more needed

"The ratings for RCN continue to reflect Moody's belief that the company will need to further restructure its debt obligations over the course of the rating horizon, and that the public notes, in particular, will be substantially impaired in any such restructuring," Moody's said in the statement.

RCN has about $1.7 billion in total debt, $1.2 billion in bonds and another $500 million in bank debt. The tender offer, which will expire Aug. 7, will retire $290 million of bond debt for about $92.5 million in cash.

RCN has also been aggressively selling its stand-alone cable systems.

In February, it completed the sale of its Princeton, N.J. cable system with about 80,000 subscribers to Patriot Media & Communications, for $245 million.

More recently, it agreed to sell its Carmel, N.Y., cable system, with 29,500 subscribers, to Susquehanna Communications for $120 million in cash.

Moody's said RCN has managed to avoid a bankruptcy filing by selling its incumbent systems. With the Carmel system going, RCN is running out of attractive properties to sell, the debt rater said.

"Moody's believes that there are relatively few remaining assets that could be divested in a similar manner," the ratings agency said in the statement. "While RCN's systems comprise a significant revenue-generating subscriber base, we believe that the company would have difficulty divesting the majority of these systems due to their overbuilt nature relative to the incumbent service providers.

"Therefore, the potential interest level in acquiring these systems by what would otherwise be the most logical buyer(s) is diminished, in Moody's estimation."

RCN vice president of investor relations Kevin Kuryla said the Moody's downgrade ignores the overbuilder's successes.

"Moody's has never been a fan of the company," Kuryla said. "They have always questioned our ability to compete against the incumbents.

"But the fact is that today, we have 465,000 customers and pass 1.4 million homes — that's 33% penetration. In addition, our average revenue per customer is $84 per month, more than 50% higher than the cable-industry average."

Kuryla added that RCN is far from out of the woods yet, but it does have options.

"There is no pending event," Kuryla said. "We do have liquidity and the ability to raise cash. We have the ability to use cash on hand and there are no covenant issues in the near future.

"The company has runway and we are exploring our options. At the same time, something has to be done with the capital structure, because we can't support this debt load indefinitely."

Trimming debt, costs

RCN is making moves to do that. In June, it cut a deal to raise about $41.5 million — which could grow to as much as $500 million — through a second lien credit facility (subordinate to bank lenders, but senior to high-yield debt) with Evergreen Investment Management Co. to help pay down debt.

And it is aggressively cutting costs. Earlier this month, RCN said it would shutter a Springfield, Mass., call center with about 350 employees.

RCN has an existing call center in Wilkes-Barre, Pa., that will remain open and is expected to add another 50 to 70 employees.

On the surface, it would appear that RCN is beginning to turn the corner. In its first quarter ended March 31, revenue was up almost 12% to about $147 million pro forma, net losses declined to $134.6 million from $150.6 million a year earlier, and RCN had its first quarter of positive cash flow ever.

On the down side, though, cash burn was $90.5 million in the quarter (compared to between $70 million and $74 million for the prior two quarters), which could deplete RCN's cash reserves faster than anticipated and affect its ability to meet its debt covenants.

Kuryla said the first-quarter cash burn rate was an anomaly, artificially raised because of a one-time increase in working capital, and should decline to past levels in future quarters.

While capital expenditures are expected to rise from the $21.6 million spent in the first quarter, Kuryla added that is mainly due to systems upgrades which will lead to increased customer connections, greater revenue and decreased churn.

Manhattan project

Last month,RCN said it would complete its upgrade of its Manhattan system — which passes about 190,000 marketable homes, mainly in apartment buildings — by the end of the year. He estimated that it would cost the company about $10 million to $12 million to complete.

Because of the microwave technology inherited from its purchase of Liberty Cable in 1996, Kurlya explained, RCN could not offer digital services, including HDTV or video-on-demand, to many of its Manhattan customers. That will all change once the upgrade is completed.

"We anticipate an improvement," Kuryla said, adding that over time, Manhattan could become comparable to RCN's top markets of Boston and Philadelphia.

Average monthly revenue per unit for Boston is $120 per month, while Philadelphia generates an average of $130 per month. RCN estimated that Manhattan ARPU was roughly 40% less than Boston and Philadelphia.

"I think it can perform as well as leading markets such as Boston and Philadelphia. New York demographics are fantastic and these technologically adept customers appreciate 3 Megabits per second of modem speed, HDTV and video-on-demand technology." Kuryla said.

Another problem market — Chicago — is also slated for significant upgrades. Kuryla said that RCN is in the initial stages of upgrades in Chicago, an analog system RCN acquired from 21st Century Communications, which should cost about $30 million.