Real Estate

Windstream debt battle opens up ‘Pandora’s Box’


Addressing a room full of investors in Las Vegas last month, Windstream’s chief executive Anthony Thomas was unequivocal. There was no way, he said, that the Little Rock, Arkansas-based telecoms company would lose a fierce legal battle with a New York hedge fund known for chasing unpaid debts.

“The only uncertainty we have around this litigation is timing,” Mr Thomas said.

Just six weeks later, Windstream found itself at risk of bankruptcy after a federal court sided with the hedge fund, Aurelius Capital Management. Aurelius then quoted the CEO’s words back to him in an extraordinary public statement this week.

“A management and a board with an extreme and unwarranted assessment of Windstream’s legal case chose to bet the company,” the hedge fund crowed. “The company lost.”

The case has caused a stir even in the sharp-elbowed world of Wall Street, as it shines a light on the ability of financial investors to hasten a company’s demise. Aurelius had argued that Windstream had violated the terms of its debt in 2015 when it spun off some assets into a separate company. Aurelius had bought about $300m of Windstream’s bonds, giving it a strong bargaining position. But it is believed to have pushed so hard because it had made a side-bet in credit derivatives which would hand it huge profits, were the company to default.

Similar dynamics were at play last year, after Blackstone-owned hedge fund GSO helped homebuilder Hovnanian refinance debt in return for the unusual requirement that the company miss a bond payment. GSO had hoped to profit from swaps that would pay out if Hovnanian defaulted.

“The judge just missed . . . the big picture”, said one hedge fund set to lose money from the ruling, noting Aurelius’ position in credit derivatives. “This decision opens a Pandora’s Box and is going to encourage a lot of aggressive behaviour”.

Aurelius’s founder, Mark Brodsky, is no stranger to controversy. A lawyer-turned-distressed debt investor who made his name in the 1990s at Elliott Management, a prominent New York hedge fund, his most famous victory came when Aurelius partnered up with Elliott in a decade-long tussle with Argentina over its defaulted debt.

But the Windstream case has pitted the two former allies against one another. Elliott is set to lose badly, holding stakes in both the telecom company’s bonds and the shares — which plunged more than 70 per cent this week — as well as an additional stake in Windstream’s listed spin-off, Uniti.

Legal experts mostly thought Aurelius’s claims were a long shot if, for no other reason, the idea that forcing an otherwise healthy company into default over a four-year-old transaction could rattle US capital markets.

When Windstream completed its reorganisation in 2015 it received the blessings of the Internal Revenue Service, the Securities and Exchange Commission and various state regulators who oversaw it. The company believed it had structured the separation of its infrastructure assets — thousands of miles of copper wires and cables — to avoid triggering any of its debt “covenants,” which are restrictions imposed by lenders to ensure they get their money back.

But things were not that simple. Knowing that the capital markets tend to reward companies providing strong dividends with high valuations, Windstream created a real estate investment trust to house the infrastructure assets. Shares in this new unit, known as a REIT, would be handed to existing Windstream shareholders. Windstream, which provides phone and internet services, would then lease the wires back from the REIT. The sum of the REIT’s value and Windstream was to be worth more than Windstream alone, before the separation.

At the time, Windstream’s debt documents explicitly prohibited such a “sale and leaseback” manoeuvre. To get round that, the company simply created another subsidiary to implement the move that it believed was not subject to this covenant. Creditors may have been upset at the time but none cared enough to complain.

Until Aurelius came along. A US Federal judge in New York agreed with the fund, ruling that Windstream’s spin-off had indeed violated debt covenants. The decision from Judge Jesse Furman surprised many observers because it focused on the company’s intent — he cited management’s testimony to regulators explaining that the spin-off was for all practical purposes a sale and leaseback — rather than the contractual language that had provided the workaround. “The court concludes that Windstream’s financial manoeuvres . . . are too cute by half”, the judge wrote.

Ugly fights between creditors and companies over clauses in dense legal agreements are nothing new. But Aurelius’s win has companies suddenly wondering what enterprising hedge fund is now combing through their past wheeling-and-dealing, looking for an obscure technical violation that could result in a ransom payment. Debt investors have recently targeted Sprint/T-Mobile and Safeway over similar covenant technicalities.

Aurelius cast Judge Furman’s decision as a victory for creditors’ rights. And yet, in its scorched-earth statement, the fund could not resist taunting rival funds who had sided with the company.

“To noteholders who chose to play the company’s game even after it had broken its promise, we wish you luck . . . we suspect you will need it.”



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