Saturday, January 2, 2010

Go Green-Ban the Yellow Pages!

Idearc Media LLC filed for Chapter 11, planning to reorganize to get out from under massive debt, and in the process, leave thousands of stockholders holding worthless paper. Idearc’s failure could easily be thought of as yet another in a long list of companies experiencing woes due to the economy, but is this the actual cause? I think someone should be asking if Verizon itself was responsible for spinning off the company with an unreasonable debt load in the first place.
Disclosure: I was a former employee and stockholder until the company announced its intention of reorganizing. Even though I’ve been widely known for predicting the “yellow pages would be toast” , my analysis indicated to that there should be a number of good years of business and revenue in print directories before anything was likely to turn critical. And, there should have been time for yellow pages companies to transition over from dependence on print revenue to create sufficient income from IYP. So, I was bit surprised by this sequence of events along with many others. Some background:
Idearc Media is one of the largest yellow pages directory companies, publishing YP directories on behalf of Verizon throughout the U.S., and operating one of the most popular online yellow pages sites, Verizon spun off Idearc as a stand-alone company in late 2006.
When Idearc made the Chapter 11 announcement , it almost immediately was met with criticism from major stockholders. After all, the company had really large amounts of cash-flow, and if truly extensive measures were taken, many wondered why the business couldn’t manage itself back out of the red and into better profitability. But, the huge debt load carried by the company has sandbagged it to such a degree that it was struggling to make Wall Street happy even before the economy went sour.
In fact, that heavy debt load was so great that when the company launched, executives immediately began applying ambitious and even perhaps aggressive focus upon pushing sales. One Idearc class action lawsuit claim which has been filed subsequent to the Chapter 11 filing, claims that executives knowingly pumped up the numbers of scheduled sales and billings by reducing debt worthiness requirements, allowing previously weak or unworthy businesses to obtain advertising on account and to be billed later — a flavor of practice which tastes much like what has caused the failures in the mortgage industry.
However, even this claimed aggressive increase in extending credit to potentially unworthy businesses likely wouldn’t have occurred if the company itself wasn’t already experiencing intensive pressures due to its heavy debt load.
This debt load came when Verizon first spun-off Idearc. The $9 billion debt load has not necessarily been due to mismanagement of Idearc’s assets and ongoing business. Verizon had decided to push away what had been one of its most profitable assets (based on profit ratio per cost — not in overall income for the Verizon umbrella company). Verizon leaders said something along the lines of “…this is no longer our core competency…”, and they pushed the division away to stand on its own. When they did that, they also required payment back for the worth of the company in order to satisfy their stockholders.
My big questions in this are: was the valuation of Idearc realistic? Was Idearc spun off with an unrealistic debt load that it would be unlikely to ever be able to service?
The fact that Verizon in the years just previous to the spinoff had undertaken one of the most massive investments in networking history in order to build a fiber optics network — aka “Verizon FiOS” — “to the premises” — all the way to people’s homes, in other words. The cost of this undertaking was incredibly massive, and some opined that it would take Verizon many more years to actually realize profits from the capital investment, if it ever would.
Verizon’s spinoff of Idearc likely came from a desire to sell off a big asset that was not considered “core” to the company, in large part so that they could pay off some of the debts created by the Verizon FiOS expansion. Approximately 22% of Verizon’s FiOS investment debt was removed by this exercise, according to some analysts. In statements, Verizon CFO Doreen Toben even seemed to directly link the sale of Idearc with a desire to reduce the company’s debt.
As part of the deal when Idearc was spun off, Verizon required that the company pay back its worth over the course of a number of years. My understanding of these debt payments was that the payment amounts would actually increase over time so that they were steadily growing — perhaps like balloon payment.
Was the size of this debt a realistic valuation of Idearc? This seems highly doubtful to me. The largest chunk of the yellow pages division’s yearly revenue was dependent upon print directories, and it was clear prior to the spinoff that print yellow pages was likely to be moving into a major decline, much like newspapers. Prior to the spinoff, analysts such as myself predicted decline in the YP print side of the house and Wall Street analysts were fast coming to see a likely trend for advertiser dollars to be moving away from print media towards online. Shouldn’t Verizon have known this, and factored that into the valuation and the debt requirements?
Obviously, Verizon felt that this part of the company was of less worth to them, rather than being a major strategic asset. Undoubtedly they perceived a weakening in this asset, coupled with a potential of being able to cash it out and use the money to help fund the FiOS project.
After the spinoff of Idearc, Verizon turned around and resold the debt instruments to other companies. The loan agreements which required Idearc to make simply whopping payments over time, were now bought by other companies and Verizon was no longer attached. Now, this may be or may have been “Business As Usual” for a splitting-off of one company from another, but the sequence rather smacks of something similar to Enron or other unsavory deals where one knowingly sells off debt-laden assets at a hyper-inflated rate, only to leave the new owner holding the bag on a worthless item. It’s these creditors which were passed the hot potato of Idearc, and they’re now very interested in moving Idearc along to be “reorganized”.
“Reorganization” sounds very positive, and sounds very responsible, but it’s essentially a euphemism for taking the company away from the stockholders in return for forgiveness of debts which Idearc could never pay. Stockholders will be left holding worthless paper in place of their investments, most likely. The debt holders end up holding the company, paid for at the expense of the investors.
The sequence smacks of a shell game, and many small stockholders are left with nothing at the end of it, and rather confused by what happened.
The whole question all goes back to the debt load, though. It’s so unreasonably high, the company just can’t function.
Yes, print media is in decline. But, it still has loads of revenue in it, even if it may be falling off by some percentage points each year.
Yes, the economic pressures also had an effect on the company bottom line, but it wasn’t the prime cause of failure. The economy at most pushed Idearc into critical mode at a faster rate than otherwise, and Idearc likely still would be facing this situation even if the economy were healthy.
Yes, extending credit to less-worthy businesses could also cause financial problems, but not to such a degree as to cause failure. Uncollected accounts are a common problem throughout the YP industry, and I doubt they were of sufficient percentage to have been the base cause of failure. The biggest financial void sucking away at Idearc’s bottom line are the debt payments — I think that even if credit hadn’t been extended as the class action suit claims, there still would’ve been a financial failure because the initial debt load was just too high.
So that leaves us with the question, who should be held responsible, if anyone should?
I’m asking these questions and putting forward this theory on the cause and responsibility of the company’s failure because a great many innocent stockholders are being hurt. From my perspective, the company executives are more focused on trying to get out from under the debt the quickest means possible, rather than focusing on their fiduciary duties — for them, it’s an exercise in changing ownership. If only the company offered their SuperGuarantee to their own stockholders! Meanwhile, I think some of the class-action lawsuits are perhaps barking up the wrong trees.
It’s my opinion that Verizon should likely be held responsible in large part for Idearc’s debt load, and they should perhaps be required to assume some of it back. I think the case could be made that the executives involved may have knowingly spun off Idearc with higher-than-reasonable debt loads, and then they turned around and offloaded that debt at a discount in return for cash.
The SEC should really investigate this. These questions should be answered prior to Chapter 11 going forward. If Idearc executives truly “explored all options” before proceeding with the filing, I doubt they explored the possibility that Verizon should maybe be held accountable for spinning off an unreasonble debt and then unloading the loans, leaving stockholders to suck it up.

Chris Silver Smith writes for the the Locals Only column at Search Engine Land. Chris "Silver" Smith is director of optimization strategies for KeyRelevance. See more articles by Chris Silver Smith >

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