EarthLink touts 'particularly strong' balance sheet, will redeem convertibles next month

By Paul Deckelman

New York, Oct. 12 - EarthLink, Inc. met with investors at a conference on Wednesday, and besides the usual kind of financial presentations companies typically make at such meetings, the company used the occasion to announce some actual news: It plans to call for redemption all of its outstanding 3¼% convertible senior notes due 2026.

The Atlanta-based internet service provider's chairman and chief executive officer, Rolla P. Huff, said that the redemption will take place "in the middle of next month." The formal notice for the redemption will be officially issued on Friday.

Besides unveiling the redemption plans at Deutsche Bank Securities Inc.'s 19th annual Leveraged Finance Conference in Scottsdale, Ariz., EarthLink disclosed in an 8-K filing with the Securities and Exchange Commission on Wednesday that it had formally given notice of its intentions to the trustee for its $255.79 million of outstanding convertibles.

EarthLink issued $258.75 million of convertibles in 2006 - the original $225 million deal plus an additional $33.75 million issued to underwriters under the greenshoe option, pricing them at par in a drive-by deal on Nov. 13 of that year.

The convertibles are first callable at par on Nov. 15, the intended redemption date. They carry a conversion price of $9.12 and a conversion ratio of 109.6491.

Huff said that "one of the biggest reasons we're doing that is that we believe the option value associated with the convertibles will get to be very expensive for us" as the company continues to execute its growth strategy and its stock price and enterprise value continue to rise.

However, he also noted that this is nothing new; he said that when he and other company executives, such as chief financial officer Bradley A. Ferguson, another participant in Wednesday's session, were out on a roadshow earlier this year marketing the company's most recent bond issue to potential buyers, "we let everybody know that that was our intention. So we're just executing what we talked about."

Following that roadshow, EarthLink priced $300 million of new 8 7/8% senior notes due 2019 on May 15. The quickly shopped deal - downsized from the originally planned $400 million - priced at 96.555 to yield 9½%. The $289.67 million of proceeds were slated for use in the redemption of the convertibles as well as for general corporate purposes.

Leverage 'next to nothing'

Huff declared during his presentation that "our business continues to generate substantial cash flow." Operating cash flow was $48 million in the 2010 third quarter, which fell to $39 million in last year's fourth quarter. However, cash flow picked up after that, rising to $52 million in this year's first quarter and to $66 million in the second quarter.

"We think our balance sheet is particularly strong compared to others that we compete with every day," the CEO said.

According to supporting materials the company distributed in conjunction with its presentation, EarthLink, pro-forma for the upcoming convertibles redemption, has lower levels of both net and gross debt and lower leverage ratios comparing those debt levels to adjusted EBITDA than a number of its telecommunications sector peers, including Level 3 Communications, Inc., Windstream Corp., Frontier Communications Corp., Equinix, Inc., Paetec Holding Corp. and tw telecom inc.

"Our leverage ratios are next to nothing," Huff asserted.

As of June 30, EarthLink had cash and marketable securities of $490 million. Less the $256 million it will pay out for the convertibles redemption, its total cash after that transaction will stand at $234 million.

Pro forma for the convertibles redemption, the company's balance sheet lists $625 million of debt - the $300 million of bonds sold earlier this year and $325 million of 10½% senior secured notes due 2016 originally issued by ITC^DeltaCom, Inc. and assumed by EarthLink when it purchased the telecom company last year.

Net debt - the debt total less the company's position of cash and equivalents - stood at $391 million.

Huff told the investors at the conference that EarthLink's investment thesis "works whether you're an equity investor or a debt investor.

"We believe that we are building a compelling business and that the valuation around that business, on either side, will expand as we continue to execute and roll out our strategy - to create a ubiquitous [internet protocol] platform that will support a managed services solution for mid-sized business accounts."

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