What pushed Excite@Home into ruin? Blame it on carelessness - or something even worse. But don't be confused: It's clear that certain financial decisions made by company board members and executives helped drive Excite@Home to destruction. It's also clear that these same financial tools are frequently used and may well be associated with other failures to come. Don't say you weren't warned.
THE DEADLY DEATH-SPIRAL CONVERTIBLE
Four months before filing for bankruptcy, Excite@Home made a risky financial deal with a hedge fund duo - Angelo, Gordon & Co. and Promethean Asset Management - to do a controversial loan providing the firm with $100 million. Excite@Home said the funds would tide the company over until the end of 2001, when execs believed it would be out of the red. In return, Excite@Home promised to pay interest and, in time, convert the loan balance into newly minted stock issued to the hedge funds.
For the two funds, this so-called death-spiral convertible presented little risk: If the stock rose, Angelo, Gordon & Co. and Promethean would earn interest and piles of hot shares of a revived Internet stock. And if the stock price fell? In its complicated deal, Excite@Home essentially promised the hedge funds they would get $100 million worth of stock, whether the price was $5 a share or 5 cents a share. At $5, Excite@Home would have to issue 20 million shares. But at 5 cents, for example, the number of shares would be reset and the company would have to issue 2 billion.
Issuing that many new shares is like a third world country printing new dollars to pay off its debts - the dilution devalues the new issues before the ink dries. Excite@Home investors figured this out, so they sold. Selling, of course, inflated the specter of dilution, which inspired more selling, which inspired more fear, which inspired more selling - that's why this toxic reset is known as a death spiral. The result was a share price collapse that hastened the demise of the company.
THE BANKRUPTCY BENEFIT
Bankruptcy law is intended to protect a business from creditors while it regains its footing. But as Excite@Home shareholders learned, companies have become awfully savvy in their use of the bankruptcy process. Through a series of mergers and acquisitions, AT&T had gained control of Excite@Home's board, holding 6 of the 11 seats. At the same time the company was struggling to stay afloat, AT&T was trying to sell its cable business. Critics complain that AT&T allowed Excite@Home to drift into bankruptcy - a move that enabled AT&T to acquire its network assets on the cheap. If the bankruptcy court casts aside Excite@Home's pesky $747 million debt, AT&T will be left with a much more valuable holding. "You begin to have basic fiduciary duty issues when a board allows a company to develop in a way that is untenable," says Bill Perlstein, head of the bankruptcy practice at the law firm of Wilmer, Cutler& Pickering.
OFF-BALANCE-SHEET DEVELOPMENT
Excite@Home was in the business of providing high-speed Internet service to subscribers of a handful of cable companies. So why didn't these companies develop their own Internet access network, as Time Warner did with RoadRunner? The answer is simple - money. Excite@Home spent more than $9.1 billion building and optimizing its network. Stacking that kind of cost on the balance sheets of the cable outfits could have been crippling. Instead, those outfits took advantage of investors' clamoring for anything Internet, and used the money to build a robust network. By developing the whole thing off their own balance sheets, the cable companies were never exposed to the massive losses of Excite@Home. Instead they were the beneficiaries of the billions spent on their service.
