Why Bondholder's View Hilton's CEO as a Grinch

By JACQUELINE DOHERTY

Stephen Bollenbach may be adored in the stock world, but in the land of bonds, he's quite the Grinch.

When Bollenbach served as chief financial officer at Marriott in 1992, the company was divided into two units, one in hotel services; the other in real estate. The deal "unlocked" value for shareholders, but it sent the company's bond ratings plunging to junk status and prompted a bondholder lawsuit.

Then Bollenbach joined Disney, where he helped engineer the $19 billion acquisition of Capital Cities/ABC in 1995. Since then, Disney's stock has risen from 58 to 107. But to fund the deal, Disney took on $10 billion of debt. During Bollenbach's tenure, Standard & Poor's lowered Disney's ratings from double-A-minus to single-A.

Now, Bollenbach is Hilton's CEO. Since he joined, S&P has lowered Hilton's rating from single-A to triple-B, owing, in part, to the acquisition of Bally's Grand. And then, last year, Hilton opened itself up to further downgrades as it tried to acquire ITT Corp. In fact, when Hilton sold almost $800 billion of debt last year, bond investors demanded and received what they thought was "insurance" against further downgrades.

As part of the bond offerings, Hilton agreed to increase the coupon on the debt if its ratings were lowered because of an acquisition of $1 billion or more. The bigger the downgrade, the larger the increase in the coupon. At last, bondholders felt they were protected.

Now they realize they were wrong.

Hilton's acquisition of ITT was thwarted by a higher bidder, Starwood Hotels & Resorts Trust. And Hilton's subsequent acquisition discussions with Circus Circus Enterprises also ground to a halt earlier this month as the two reportedly couldn't agree on such pesky details as valuations or management structure. Hilton had hoped to separate its gaming and hotel operations into two companies and then merge Circus Circus into its gaming group.

Now it appears that Hilton is still considering splitting in two, even if an acquisition isn't involved. And that could mean trouble for bondholders because the "insurance," or coupon increase on the bonds, kicks in only if the rating downgrade occurs because of an acquisition. If the downgrade occurs because of a reorganization or a split-up, bondholders are out of luck.

Essentially, bondholders have found they bought insurance for the wrong thing. It's as if they bought flood insurance and they're watching their houses burn down.

Hilton's 7.2% debt due in 2009 was sold at 99.8 in December and now it trades at 96.75, a loss of almost $30 for a $1,000 bond.

A Hilton spokesman declined to comment on the company's debt. But he said splitting the company "was still a possibility." And he added that Bollenbach had "waived provisions" in his employment contract that allow Bollenbach's stock options to vest ahead of schedule if a split occurred by June 30.

It's possible that the company remains whole or does a large enough acquisition to trigger the coupon increase on the bonds. In that case, the bonds could trade up. But if the split-up occurs with no acquisition, the bonds could trade down further if the ratings fall, one trader explained. "I would never touch these bonds," declares Carol Levenson, who publishes Gimme Credit, a bond newsletter. "We've been encouraging bond investors to avoid this name since dinosaurs walked the earth."

And Zane Brown, director of fixed income at Lord Abbett & Co., says his firm bought Hilton's convertible bonds instead of its traditional bonds to participate in the equity upside of a potential split. "Hilton is in the same industry, ripe for the same type of maneuvering [as occurred at Marriott]. It made a lot more sense to be in an equity position than in the debt position," he observes.

We know the government's auctions of airwave spectrum raised the disappointing sum of $578.6 million, but it's tough to figure out just how the winning bidders will affect the rapidly changing telecom world.

The spectrum sold last week is for something called local multipoint distribution service, or LMDS. With it, a company could get its phone, TV and Internet access by using radio signals sent through the air instead of depending on cables and wires owned by telephone or cable television companies.

In many ways, the technology is similar to that of a cellular phone system. But with LMDS, the sender and receiver must be stationary and the signal has the capacity to carry large chunks of information, such as data files. In contrast, a cellular phone is portable but can only carry voice or short data messages. Since the two have such different applications, companies using LMDS waves and those providing cellular phone service aren't expected to compete for the same users.

"You don't substitute one for the other. It's like having a boat and a car," one analyst explains.

However, in an earlier auction, a number of companies had bought spectrum that's similar to the one used for LMDS. The two types of spectrum have some differences, but they can transmit essentially the same amount of information, just as quickly and in a similar fashion. Companies such as WinStar Communications, Teligent, Advanced Radio Telecom all bought spectrum in the earlier sale and have sold junk bonds to finance the startup of their systems.

At first, some feared that the low price fetched in last week's auction would hurt these companies. But it appears that the market is much more focused on how well management is executing its business plans, for the cost of spectrum is just a sliver of the total tab for getting one of these systems running.

So, who will come out ahead in this new type of communication?

"He who gets the spectrum and starts to deploy it first has the advantage," quips Robert Waldman, head of corporate bond research at Salomon Smith Barney. He has "buy" recommendations on WinStar and Teligent bonds.

Right now, WinStar is farthest along in its development, with Teligent one to two years behind, and the LMDS winners at least two years back in the race to provide meaningful service, estimates David Wells. Wells, the high-yield analyst at Societe Generale Securities, has a "hold" recommendation on WinStar paper, because of the recent rise in its price, and does not rate Teligent.

Although the spectrum might not have fetched as much as expected, the good news from the auction was that only one party, WNP Communications, emerged as potential competition. WNP bought a huge amount of spectrum that covers 114 million people. But that's still smaller than WinStar's coverage of 185 million or Teligent's 130 million.

"It's clear that only one significant new player, WNP, came out of the auction. No one compiled a national footprint as large as WinStar or Teligent," notes Leslie DeBauge, a high-yield telecom analyst at CIBC Oppenheimer. It's one of the reasons she's put out a "buy" recommendation on both WinStar and Teligent bonds.