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CASH IS CONSTANT STRUGGLE FOR PCS PLAYERS

NEW YORK-For successful bidders in the government’s C-block auction for personal communications services, “the good news is you’ve got a license; the bad news is you’ve got a license.” So said Norman C. Frost, Jr., managing director at Bear, Stearns & Co. Inc., sounding an often-repeated refrain of cautious optimism in the financial services community about the near future of C-block bidders.

Rising tides in the stock and high yield bond markets may well lift all boats in 1996, making it possible for C-block bidders with new PCS licenses to raise public capital for the next phase of their development. But a glut of new issuers could easily overwhelm demand, so those with enough advance backing to time their debut are best positioned to gain strategic financing advantage.

The first quarter of 1996 will be a short but critical period for auction participants, and it won’t be the last major hurdle either. In the first few weeks of the long-delayed auction last month, a wide gap opened between a dozen or so top-tier bidders and 100 or so in the next-closest echelon, said Kenneth Doyle, senior associate for telecom, media and technology banking at Merrill Lynch. Before the bidding closes, a variety of behind-the-scenes negotiations are likely to occur, particularly among the smaller players.

“There are two ways out,” Doyle said. “You can always back out of the bids, which will cost you a good chunk of your equity, or you can go ahead and look for more money. Therefore, (participants) will be looking for arrangements during the auction.”

Bigger often is better, particularly in key markets, even though the per-pop price tag is substantially higher. But small players in strategically located niches where auction prices are likely to be lower may gain the advantage of a unique service in areas not cluttered by competition from similar providers.

“If I were investment advising a C-block auction participant, I’d say that bidders should have a lot of cash in their pockets going in, and know where future financing will come from,” said Frank Stiff, managing director and president of The Columbia Group, an investment bank based in Alexandria, Va. “In cellular, people didn’t know where the money would come from, but they knew it would come from somewhere. But it’s not clear there’s a large group of investors waiting for PCS.”

Participants going into the auction with “dry powder” left over to carry them part way through the post-auction, pre-construction phase are most likely to succeed because the cash cushion will better position them to attract new capital in a manner best timed to get best terms, Frost said.

Frost is more encouraged than Stiff about the public investor potential for PCS providers. “In the mid-1980s with cellular, companies were in the market with projections of multiples of cash flow; now companies are in the equity markets with future cash flow projections. With new players, there are risks but also the advantages of a new technology and a green field,” he said. “And there are some very focused and sophisticated growth mutual funds and some pension funds that stretch for returns.”

Like Frost, Richard Frisby, managing partner of Battery Ventures, a Boston venture capital firm, said he believes that “the opportunity for transition from wireline to wireless is bigger than anyone has imagined, and will produce substantial positive cash flows for some companies.

“There are opportunities to carve niches for themselves and thus be successful,” he added. “But the big question mark is whether there are too many participants.”

Another big issue, according to Doyle of Merrill Lynch and Frost of Bear, Stearns, is whether the very Federal Communications Commission rules that made it possible for small businesses to compete in this auction will hinder their ability to raise capital. Strategic alliances with deep pocket entities are necessary for short-term and long-term success. However, FCC requirements designed to maintain control by the core groups comprised of small investors within designated entities impose obstacles to seeking big outside investors.

“By definition, DEs are small businesses. The most challenging process from a financing standpoint is that it’s hard to structure a transaction due to several elements required by the FCC.”

In the difficult pre-license phase of capital raising, a variety of techniques were used. “Unfortunately, C-block operators had a tough time raising money because, without a license, public investors viewed this as a blind pool,” said Jeffrey L. Hines, a telecommunications analyst for PaineWebber Inc.

Following a cardinal rule of capitalism, it often is the case that to get money, you have to have money. “Several avenues were available to bidders large and small. But to start, you have to have experts who know the business and are well-connected in telecommunications and financial circles,” said Peter Nighswander, senior consultant for Economic Management Consultants Inc., Washington, D.C.

“We’ve only had a small picture of the financing so far*…*equity capital from strategic partners, some venture capital but not very much, little of the traditional passive financial players in this market,” said Stiff of The Columbia Group. “Some of them may be financing this thing on MasterCard and Visa.”

A key source of startup funding has been Asian business, according to Robert Kyle, chairman of the Small Business PCS Association in Denver and of QuestCom Inc., based in San Francisco.

“Funding for PCS has been so difficult for small groups, but a lot of offshore money has come in from a full spectrum of Korean and Japanese companiesfinancial, telecom, trading, electronics,” Kyle said. “One of the major investors in QuestCom is Samsung, the largest company in Korea. They called us.”

Because FCC rules limit foreign investors to a 25 percent ownership stake, such companies have in some cases provided loans in order to bypass the 25 percent limit, Kyle added.

According to EMCI’s Nighswander, advance loan agreements with technology vendors-often for more than actual equipment costs-likely have played a key role in bringing bidders to the auction. These arrangements also will be pivotal in the post-license, pre-construction phase of PCS systems development.

“The interest on the licenses is substantial-at prime for six years with the balance due in another four; it’s unlikely you’ll go cash-positive for at least four to five years, and the capital expenditures are substantial,” he said.

Vendor debt may be the best financing route for the pre-construction phase, although much of that capability may already have been used up in the pre-auction phase, said Merrill Lynch’s Doyle. Vendors are most likely to finance DEs in strategically located geographical areas or those able to buy enough blocks to make investment worthwhile, he said.

The typical starting point for small businesses would be venture capital, but C-block bidders do not present a normal venture capital venue.

“Venture capitalists are looking for 40 percent to 50 percent returns, but in this case, most of the value is taken up at the auction, and like it or not, they won’t have any control for five years,” Doyle said. “There is some venture capital financing, where venture capitalists are betting on a person they know.”

As an example, General Wireless, which made an upfront payment of more than $50 million for the C-block auction, received venture capital backing from Battery Ventures and from a private placement involving convertible debentures that was arranged by Bear, Stearns. These debt instruments can be converted into equity when there is enough domestic capital in the company, Frost said.

“General Wireless was one of several bidders, another was U.S. AirWaves, that received traditional venture capital,” said Frisby of Battery Ventures. “Others, like GO Telecommunications received venture capital from sources like Fidelity and Columbia Capital that are not pa
rt of the traditional venture capital network.”

Borrowing from commercial banks is another typical route for startup small businesses. However, bank loans have been difficult for DEs to obtain because risk-averse bankers are disinclined to lend to negative cash flow companies, Doyle said. Here, too, participants with big backers are most likely to have gotten this type of financing early on.

The most likely route for the post-license, pre-construction phase will be tapping into the public, high yield debt markets, using zero coupon bonds, reserve notes and other mechanisms whereby no upfront interest payments are required, Frost said.

Initial public equity offerings also are likely and will be necessary, although this form of capital is quite expensive. “If you don’t have to, don’t go into the equity markets right after you win the license because the real step-up in value will come when you put in subscribers,” Doyle said. “At this point, equity will be extremely expensive, if doable.”

Saying that PCS C-block winners need good stock market “tail winds,” Doyle said good news about companies like American Personal Communications in Washington, D.C. will help everyone, while bad news will hurt APC first.

Private placements also are a likely source of financing in this transition phase, said Hines of PaineWebber.

While financing options will ease somewhat in the next phase, even those most optimistic about the future urge caution.

“If the auction concludes in mid-March and there is a scramble for capital, some players will fall by the wayside,” Frost said. “The question then will be what to do with the zombies, the walking wounded.”

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