October 2, 2002
Are the Lucent bonds a bankruptcy Predictor ?
Our main concern for Lucent (LU-NYSE 0.79) these days has been the price of her bonds. Up until today (where there has been a slight recovery) the short term bonds were priced in the 30’s. To us they had “pending bankruptcy” written all over them. We keep thinking that the bond market is the “smart market”. Yet, we search and can find no clues of a pending bankruptcy. We keep wondering if there is knowledge out there of a filing to happen soon. Well, we can’t find any such information. Things surely do stink in telecom land, yet Lucent still claims “liquidity” . There was a recent Lucent article written by Ben Klayman of Reuters. He wrote how Pat Russo has been claiming liquidity and that Lucent expects to eventually profit after the depression ends. Here is a link to that article http://biz.yahoo.com/rb/020918/telecoms_lucent_ceo_8.html . We spoke to Mr. Klayman after he wrote the article and asked him if perhaps Lucent was hinting at a bankruptcy filing. He was interested in such an interpretation, yet discussed that during his Lucent interviews the hinting of bankruptcy just was not there. He indicated that those interviewed for the article most certainly see an opportunity for Lucent to once again become profitable without a Chapter 11 bankruptcy filing.
It so happens that Reuters wrote another article last week. We were quoted in the last paragraph of that article on the reduced spending in the telecom.
The following is a discussion on Lucent bonds. We refer to several quotes from an article we recently read called ” The Tech Stock Hero in Bonds”. The article did not mention Lucent at all, yet we found several passages to be quite Lucent appropriate. The article is from ” The Technology Market Advisor”, July 2002 issue ( http://www.gildertech.com ) . The authors’ describe an interesting scenario which potentially helps explain the recent pricing of Lucent bonds (priced for bankruptcy). The author describes the technology investor who sees his technology stock plunge to a dollar or two a share. He accurately goes onto discuss the reasoning of why the technology investor has no interest in selling these battered shares (think Lucent). For this investor, the current price “might as well be zero. Psychologically it is zero.” The investor has genuine concerns that selling at or near a dollar would be the worst thing to do, especially if the the stock recovered to much higher levels. Remember, during all this we still see the possibility of Lucent’s business model recovering without the use of a Chapter 11 bankruptcy filing. Hence, lets accept that as long as Lucent has a potential profitable business model and a potential recovery of share price that we may not sell our shares. Keep in mind that our holding of the shares corresponds with our views that there is a distinct possibility that Lucent could declare bankruptcy and the share price could go to zero.
Remember, the bonds are trading in the 30’s and are indicating “priced for bankruptcy”. The bonds were previously selling in the 90’s not to long ago (scroll down to December 3, 2001). The bond investor seems to be behaving in the opposite manner as the technology investor. The bond investor is selling as he sees the price deteriorate. The bond investor is generally more conservative than the technology investor, and the goal of the bond investor is to preserve principal. The bond investor when he bought the bonds, fully understood that the upside was limited. Hence a deterioration of the bonds to the 30’s from the 90’s is a horrible disaster and will generally be avoided at all costs. Hence , the possibility exists that the Lucent bonds have been a victim (and a well deserved victim at that !!) of unbiased selling at any price. The bond investor realizes that the loss exists, yet unlike the stock investor in Lucent which we described above (hold to zero), will sacrifice his shares for a price of say even 40 cents on the dollar. The bond investor , like the the shareholder of the common stock realizes that Lucent has its inherent dangers of going bankrupt and by nature would prefer a “defeat before a rout”. “Thus that precipitous drop to the 30’s almost certainly reflected selling pressure not linearly related to the quality of the bonds. When a very large investment grade debtor first turns into a very large high-yield debtor, sellers typically outnumber buyers by a wide margin and the bonds sell at a discount”. The Lucent bonds most certainly fell apart after Lucent dropped the bomb on Friday the 13th, 2002 where they indicated that revenues would be substantially below the previous quarters revenue figures. We were projecting downsized revenues of 2.65 billion for the quarter ending September 30, 2002. We were using as our worst case Draconian scenario revenues of 2.50 billion. Lucent has guided that the revenues may actually be as low as 2.20 billion. What a shock that was.
The logic of the bonds and the pricing reactions seems to possibly apply to Lucent. Please don’t misinterpret what we are writing. In our view, Lucent has never been a greater contender for bankruptcy as it is now. It is our view that Lucent could file for bankruptcy at some point during the next 3 years. It is even possible to see a filing within the next 4 months. We are hoping (and all we can do is hope at this point, since data will not be supplied by Lucent until their quarterly “loss” announcement on October 23, 2002) that the ” bondholders are running away as fast as their little risk-averse feet can carry them…”
We are not recommending the purchase, sale or hold of Lucent to anyone reading this article. Please do your own due diligence or contact our office to discuss any of these or other issues.