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November 27, 2006 6:45 pm

Iridium update for fellow investors

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Back in September, for those readers contemplating betting on an unfamiliar horse on a wet track, I suggested they consider buying bonds of Iridium LLC, which went bankrupt in 1999. Sometimes risky bets win and so far the market value of these bonds has increased by some 20 per cent. Apparently, distressed securities investors like what they have been hearing at a trial in the New York bankruptcy court of Judge James Peck.

Iridium was then the owner of the Iridium satellite system, which is not considered one of the business successes of the past technology boom. The original phones were bulky and difficult to use, the bandwidth inadequate for most remote data communication and the service expensive.

Motorola designed and built the system and the handsets and charged Iridium more than $3.7bn for the equipment and its services. The system was sold in bankruptcy for $25m after being in service shortly after the bankruptcy filing.

You may recall the advertising campaign, which showed trackless deserts, empty reaches of sea and other landscapes devoid of mobile phone towers. They were also devoid of human beings, which raised the question of how many people would buy the service. Fewer, it turned out, than assumed in projections.

What makes this of more than academic interest to the financial community now are the defaulted debt issues, the bank debt and claims by the holders of the common shares. They have been pursuing Motorola through the bankruptcy courts for eight years, claiming that for various reasons, Motorola should make them whole. Motorola begs to disagree. By now, with claims for accrued interest charges, the total in dispute is more than $4bn. Up to now, most of the legal action has been in a discovery process and the litigating of motions for summary judgment. That is now over, and the initial trial of the creditors against Motorola has begun.

The case is divided in two parts. In the first, which will conclude in the next two weeks, the creditors’ committee is attempting to prove that Iridium was insolvent from at least 1995, contrary to what the investors were told. If it was insolvent, they argue, then Motorola should repay all the money that it received for its equipment and services up to the time of the bankruptcy.

They say that the equipment and services should be valued on the basis of a reasonable expectation of the discounted cash flows from the operation of the system. They allege that Motorola’s engineers and managers knew, or should have known, that it could not possibly meet the market’s needs. At the time the equipment was purchased it was put on the books at cost, less the depreciation that accumulated over time according to Generally Accepted Accounting Principles and tax formulas.

For the bondholders to prove, in this phase of the trial, that Iridium was insolvent from early in its short life, they have to convince the judge that the equipment was really worth less than it cost. That is a challenge.

Motorola’s formal position, according to a spokeswoman, is that: “The plaintiffs in this case – purchasers of Iridium’s bonds – bought the bonds with an understanding of the Iridium concept and knowing the risks associated with their investment. These investors also knew that Iridium would use proceeds of their investment to pay Motorola for its satellite constellation. Their lawsuit is an attempt to redo that deal with the benefit of hindsight.”

What is at risk for Motorola in this phase of the trial is not just the billions in damages for the Iridium creditors but the precedent that would be established for other purchasers of past or future Motorola technology that did not turn out to be profitable for the buyers. So they will not settle.

I have some sympathy for the company on this point. If Iridium had been started by someone or a group or people unrelated to Motorola, using their own money, then they should have applied some better common sense tests to the concept. But to my mind Iridium was not started by unrelated people. I followed its launch from the beginning. It seemed clear to me, and to everyone I knew, that Iridium was a Motorola creature from the beginning and, I thought, remained one to the end.

That is not the issue in this trial but it will be an issue in the next phase of the Iridium case. And while it is my best guess that Motorola will win on the law in the present phase of the trial, the facts that have been brought out can be used against the company.

Matthew Dundon, a lawyer and securities analyst with Miller Tabak, has been following the Iridium case. As he puts it: “If Motorola is found to have controlled Iridium, then the burden shifts to Motorola to prove the contracts it had with Iridium were entirely fair. The evidence presented so far clearly goes to show you cannot prove that.”

Indeed, the parade of engineers, managers and marketing people from Motorola and Iridium presented to Judge Peck’s court are a near-comic illustration of the worst of corporate group-think. The problem is that there were Motorola people on the board and ex-Motorola people in management, along with a dependence on Motorola technology and planning.

Mr Dundon, in support of the creditors, says: “Iridium was really a product-specific marketing division of Motorola.” If Judge Peck agrees with this view in the next phase of the trial, Motorola has got a multi-billion dollar problem. It will not destroy the company but it will cost a bunch of cash.

Most likely the case will be decided before next summer. Whatever the outcome, there may be two levels of appeals courts after that, which means a verdict might only be final by 2010 or 2011. If the creditors lose, they get nothing. If Motorola loses, refuses to settle and loses at the appellate level, then the award with interest could be well over $4bn.

Lawyers who are not engaged in the case guess that Motorola might settle for $500m just to make it go away, and the creditors would consider taking $1.5bn, if it were offered now. Those numbers are too far apart for an agreement. The certainty on both sides that they are right makes for a fight to the end.

The bonds are about 29-30 per cent of their original face value. In present value terms, they have some way to go to the upside. But like all distressed assets, they are not shockingly cheap.

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