Where the Rigases went wrong

When you think of the crisis facing Adelphia Communications, don't think Enron. Think Worldcom.

At Enron, the emergence of debt hidden off the energy company's balance sheet was so enormous that it pulled the company under. The $2 billion to $3 billion in debt popping up at a partnership tied to Adelphia Chairman John Rigas probably isn't enough to do that, Wall Street credit analysts say. (And certain elements of the debt were
disclosed earlier—perhaps not very clearly or completely—in Adelphia's SEC filings.)

The better comparison is to Worldcom-esque insider dealing. That telco's chairman, Bernie Ebbers, was harshly criticized for buying its stock, first by getting Worldcom the company to guarantee loans from a bank and then by borrowing $374.7 million directly from Worldcom. When the stock value sank below the outstanding debt, Ebbers had trouble repaying.

That's the big surprise here. The Rigas family—son Tim is CFO, son Michael an executive vice president—was using Adelphia's balance sheet to finance purchases of $824 million of Adelphia common stock and convertible debt. Existing public shareholders weren't told that they were financing the Rigases' dealings. Nor were the buyers of $2.5 billion in securities that Adelphia sold in November and January.

The family has steadily bought stock in Adelphia for years, piggybacking on every common-stock or convertible-debt deal sold to the public. That kept the new investors from diluting the family's control. The Rigases now have 24% of the equity but a majority of the shareholder votes.

For months, Adelphia watchers, particularly Merrill Lynch bond analyst Oren Cohen, have questioned the source of the Rigas family's cash. Clearly, the Rigases were borrowing to finance $824 million in recent stock purchases. But the securities don't yield enough cash flow to service much debt.

So why would anyone lend?

The answer is that, like daddy co-signing son's car loan, Adelphia was co-signing loans to the Rigases' private Highland Holdings. Banks can collect from Adelphia if the stock price collapses and the Rigases can't pay.

It was analyst Cohen who asked in an investor conference call about an odd footnote in the company's earnings release. That and the company's awkward response triggered the panic.

"There is self-dealing here, and it should be disclosed in detail," Cohen said.

The Rigases have a long history of insider dealing. Adelphia's cable systems often sit in buildings owned by a privately held Rigas company. Adelphia sometimes sends system construction projects to the same company. Also, instead of buying converters from a manufacturer or arranging outside lease financing, a Rigas company finances the deal and collects lease payments. Adelphia's SEC filings show that, in 2000, the company paid $15.8 million to family-controlled companies for property, plant, equipment and services.

Morgan Stanley bond analyst David Allen argues that, "as they were putting money into the company, they should have disclosed where that money was coming from." However, though not a big fan of the Rigases, he believes that the company can probably restructure its debt by slashing capital spending and selling some assets: "It's manageable."

The Rigases were fairly quiet last week. They acknowledged that the SEC has begun an inquiry. They named a squad of bankers and lawyers. They delayed Adelphia's annual 10-K filing due last Monday.

But they didn't offer what investors are clamoring for: precise details on the structure of the debt and assets at Highland Holdings.

Adelphia's crashing stock price (off 53%, from $22.34 to $10.50, in 10 days) means that Highland's debt may exceed its assets by $300 million to $500 million. Then the question is: Are the Rigases' shares actually at Highland, or does Highland hold a note to yet another family company? Highland holds 300,000 cable subscribers generating about $100 million in annual cash flow, but that's worth only $1.2 billion or so.

The Rigas silence is no surprise to Cohen. "We've all known for years there have been related-party transactions. We've always wanted greater clarity, never gotten it."