ADELPHIA COMMUNICATION CORP’S
BANKRUPTCY A case analysis
1. Case facts and Summary
In 2002, a massive accounting fraud and corporate looting scandal involving the founding Rigas family made Adelphia the 11th largest bankruptcy case in history, and the third--after WorldCom and Enron--among those triggered by fraud. The four cable companies – Aldelphia , Time Warner, Comcast, and Cablevision – collectively served over 50 percent of all 73 million U.S. cable television subscribers. In 2005, Adelphia was contemplating several options to emerge from bankruptcy, including a $17.5 billion cash-and-stock offer from Time Warner and Comcast, a $17.1 billion cash-only offer from Cablevision, and a $15 billion cash-only offer from Kohlerg, Kravis, Roberts, & Co. and Providence Equity Partners. Since both Comcast and Cablevision are themselves family-controlled companies and with a large wedge between the family's ownership and control rights, it further complicates the decision. 2. Understanding the reasons for Adelphia’s bankruptcy Problems arising due to a family’s disproportionate control in a public company -
Adelphia and other Multiple Systems’ Operators serving almost 72% of the market were often owned and / or managed by their founders or the founding families. Even when most of these companies went public to finance expansion, the founding families tried best to retain control by means like reserving for them a separate class of stocks with superior voting rights. When Adelphia went public in 1986, it still kept control over the firm by using a dual class structure of shares (to keep the voting rights – 62.9%) and by staffing the board with family members (to keep a control on the board – 89%). The Rigas Family kept 100% of Class B shares (10 votes per share) to themselves and issued the Class A shares (1 vote per share) to the public. This way they had 62.9% voting control while holding just 25.9% of the stock. The Rigas Family also kept some of their cable-assets to themselves in several private partnerships and continued to buy properties privately and for Adelphia both. The privately held cable properties were managed and operated by Adelphia under management agreements for about 5% of quarterly revenues. Even though all the subsidiaries and Adelphi reported their operating revenues and other expenses, the financial results of Adelphia were never accounted for in these financial statements. Co-borrowing with Rigas Family and Misrepresentation of facts -
During the growth period of the 1990s, Rigas Family members looked for ways to purchase more stock without borrowing money on their own account since they didn’t have enough collateral. At this point, the concept of co-borrowing came into place under which the Rigases could tap into 200mn $ loan that was deposited in company’s cash management system. Under this system, both the co-borrowers were jointly and severally liable for full amount of indebtedness – who actually got the funds didn’t matter. Since the board was in the hands of Rigas Family, they entered into some other such arrangements between 1999 and 2001. Since the stock prices were rising, they could actually put the stock of the co-borrowers as collateral – and continued to get more debt financing.
The main problem started when they started excluding significant portions of Co-borrowing credit facilities from Adelphia’s financial statements by stating that the debt existed only on the books of entities owned by Rigas Family. From mid-1999 to 2001, Adelphia understated its consolidated liabilities by up to $2.3 billion by failing to record a portion of liabilities associated with the Credit Facilities under which Adelphia was a co-borrower with certain Rigas Entities. This was to underreport Adelphia's overall debt, portray Adelphia as de-leveraging, and conceal Adelphia's inability to comply with debt ratios in loan covenants. SEC claimed that the omission of co-borrowing credit facility debt was deliberate and intended to mislead. When Adelphia announced in a footnote in company’s 2001 annual report the omission of 2.3bn $, more information was requested about the co-borrowings. When the actual usage was found out, the stock prices fell 27% in 2 days. After Deloitte refused to sign off the annual report, Adelphia’s stocks were de-listed by NASDAQ. Next day onwards, the company started to default on its debt payments. Almost a month later, the company filed for bankruptcy, listing 19bn $ in debt. 3. Future of Adelphia: stand alone or acquisition
Initially Adelphia was a family- controlled company. After bankruptcy, new management was selected, but the company had been fudging its account for years. So the main challenge was to get the clear understanding of the company situation. Now to keep the company alive as a standalone company, they would have to renegotiate with the creditors and financially restructure to repay huge debts. It would take years for the company to operate normally and generate profits if at all possible. No company would come forward to give them debt. If the company considers the option of liquidating its assets then they get only 12.685 billion whereas it will be of more value if they sell the company to existing cable owners. 4. Evaluating the Bids
Time Warner-Comcast Time Warner cable and Comcast are have big market shares in the cable industry. They have maintained high profitability and have been expanding to benefit on economies of scale. Hence, with a strong incentive, there is low risk of backing out or further bargaining for lower price. However, though the value is higher ($17.6 bn), $4.96 bn of this was in the form of equity of TWC. Hence in this deal Adelphia holds the risk of TWC equity versus risk less cash. Therefore, we have look into the workings and profitability of TWC also. TWC has about 11 million subscribers and has also maintained a good profitability. However risk lies in how investors will react to the new acquisition of Adelphia. And also, since TWC is providing stock, the share might be overvalued. Pre-acquisition performance of Time warner Share price Debt/equity Ebitda/sales (whole company) EBITDA/sales (cable operations)
$16.71 0.165 based on market value of equity 15% 38%
Post- acquisition performance of TimeWarner Ratios for TWC after acquisition of Adelphia
EBITDA/sales PAT/sales ROA Debt/equity
2006 33.85% 5.5% 1.4% 0.74
2007 35.57% 7.52% 2% 0.702
From the ratios the profitability seems to decrease immediately after acquisition but is increasing later as shown in the table above. The investors might take this positively because of the expansion and the economies of scale. Leverage, however is not very low. Also, in the Time Warner company, the founding family has a negligible stock share as well as control share pointing towards more professional management. Other problem include
Uncertainty of a successful IPO by TWC after acquisition. With a complex structure involved and many stakeholders taking part, the deal might turn out to be more expensive and time consuming.
Cablevision
Cable vision submitted a bid for Adelphia at $16.5 bn cash and later raised it to $17.1 bn cash. Cablevision was a minor player in the industry with about 3 billion subscribers. In spite of a good deal, there might be underlying risks. Being a last minute deal, the certainty and commitment were doubtful. Also the source of funds needed for acquisition was not clear. Given the leverage and the size obtaining huge debts at a short notice would be difficult. However, being a single acquirer and a smaller one, the deal might be quicker. It is important to compare the risk of backing out by cablevision versus the risk of equity in the case of Comcast.
5. Time Warner Inc& Comcast Deal in detail
Time Warner Inc& Comcast Corporation have jointly come up with a bid of $17.6bn with $12.65bn cash and the remaining part as 16% stake in Time Warner Cable.
5.1What’s in it for all the stake holders of the deal? Comcast Corporation
The joint bid would help Comcast monetize its stake of 21% in TWC without paying much tax. It was a good deal for Comcast to sell away its stake in return not only for money but also half a billion subscriber base from TWC. Also by exchanging subscribers with TWC, Comcast was getting 0.13 billion more subscribers. This might give an advantage in term of consolidating its customer base and improving operational efficiency. Initially it would reduce its stake from 21% to 17% in exchange for subscribers and cash. Later on this stake would be divested by the trust. Comcast is to pay $3.5 bn in cash for Adelphia and will be getting cash of $1.9 bn in return for the stake in TWC. So, net cash outflow for Comcast will be $1.6 bn.
Avoiding heavy taxes
By creating separate trusts to hold the shares and then exchanging ownership instead of directly selling back the stock.In this way Comcast by swapping assets for its stake in TWC instead of cash would avoid heavy capital gain taxes. It would further acquire regional clusters of subscribers that would complement its existing network. Time Warner Inc
At the end of the deal Time Warner will own 84% of TWC's common stock, which would consist of Class A shares and Class B super-voting shares. The remaining 16% of TWC's common equity which was held by Comcast will initially be owned by Adelphia stakeholders and is expected to be publicly traded in the form of Class A shares. This (7984%) would increase the ownership of Time Warner Inc and give them more financial flexibility. The whole deal will help TWC expand geographically as it would swap clusters with both Comcast and Adelphia. It would gain approximately 3.5 mn basic subscribers - 3 mnfrom Adelphia and > 1 mnfrom Comcast, and will give Comcast 750,000 of its current subscribers. It will then manage a total of approximately 14.4 mnsubscribers - 12.9 mn consolidated and 1.5 mn in 50%-owned continuing joint ventures with Comcast.
Common Interest for both the companies:
Moreover a joint bid would allow the companies to take on less debt than they would otherwise take if they had individually bid. The deal would also facilitate expansion as the companies could swap the regional clusters in a way that would complement their existing networks. Less debt would mean reduction in risk which will make investors less wary about companies adding to their debt capacity.
6. Conclusion:
After understanding and evaluating the various options in front of Adelphia Corporation, It seems that the best way out is to accept the Time Warner and Comcast deal. The stock of TWC seems to be valuable for the creditors and banks of Adelphia to own.
