Vultures Circling Around Vitesse

Vitesse Semiconductor Corp (VTSS) is mentioned yet again in today’s WSJ. Bondholders are descending on companies who have failed to file financial statements with the SEC due to options backdating investigations. Technically, these companies are in default and bondholders can demand immediate repayment. If the company cannot pay, they could be forced into bankruptcy.

From the WSJ:

In the bond business, a standard indenture — a detailed contract between an issuer and investors — requires a company to file quarterly and annual reports with bondholders at or around the same time it files with the SEC. A company usually has 60 days to meet its missed filing deadline. Since a late filing is a technical default, so-called vulture investors, who typically buy bonds that trade at a discount to their face values, see a chance for a fast profit if a company can be forced to redeem at full value. The option-backdating probe, which has knocked down the bond prices of many of the companies being investigated, has provided a fresh opening for these investors.

Vitesse crossed into this territory last week (Aug 21st) when the 60 day grace period expired. This should not have been a surprise to anyone, though the stock did sell off.

Vitesse has some options. Sanmina SCI (SANM), another company bit by the backdating bug looks like they will convince extortionists bondholders by offering a 1-2% protection payment to existing holders. If Vitesse can extract like terms this would be a manageable sum of a few million dollars.

The alternative scenario is that Vitesse bondholders decide to press the letter of the law and force Vitesse into bankruptcy. This would allow bondholders to effectively seize control of the company and dilute/eliminate the existing shareholder base. As it stands today, Bondholders can only realize a full coupon payment, a gain of about 25-30% above current bond prices (VTSS CUSIP #928497AD8). A bankruptcy event would hand over ownership of the company to the bondholders, and assuming they could turn the ship around, much larger gains realized. This process would take years, and it is unlikely that the company would survive in any valuable form.

The other alternative is to simply give bondholders what they want- equity. Vitesse could take the $98M in outstanding convertible debt and issue equity, provided the bondholders agreed.

My personal opinion? Vitesse bondholders won’t take the company into bankruptcy. This is simply a positioning move to extract a few points of tribute, or an attempt to swap their debt for what I believe is an attractively priced distressed equity.