MGM Deal With Pathe May Cost Its Bondholders

Some MGM/UA Communications Co. bondholders are beginning to fear that they--along with the federal government and at least one troubled thrift--will be losers if Pathe Communications Corp. completes its long-delayed plan to buy the studio.

MGM/UA’s $400 million in junk bonds, issued in 1986 by now-defunct Drexel Burnham Lambert Inc., have traded lately at only about 60% of the price they commanded when Pathe first announced its $1.3-billion buyout last March, largely because of concerns about the financial viability of the merged companies.

Some holders, moreover, are now complaining that Pathe’s plan to finance the purchase partly by selling long-term rights to the MGM/UA film library will jeopardize the company’s ability to make interest payments or redeem the bonds when they mature. The Pathe plan also may violate covenants in the bonds, they say.

“We think there’s a real problem,” said a source close to Columbia Savings & Loan, an insolvent thrift that owns $38.6 million worth of the bonds. “Someone has found some loopholes and is driving a truck through them.”

A Pathe spokesman said his company hasn’t received any formal complaints from bondholders and doesn’t believe that there will be any violation of covenants or deterioration of credit standing as a result of the rights sales.

In a statement, MGM/UA Executive Vice President Kenin Spivak said his company “takes seriously the confidence” investors have shown by purchasing bonds.

He added: “We have structured the Pathe merger to ensure the solvency of the company and our compliance with our obligations to creditors. Among the steps we have taken to ensure the company’s ability to service its debt are obtaining appraisals of Pathe’s assets and a solvency opinion from America’s leading firms in the field, including a requirement in the merger agreement that the financing . . . must comply with our (bond) indenture(s).”

In New York Stock Exchange trading Wednesday, MGM/UA’s 12.625% 1993 bonds closed at $62, up $4.50 in moderate trading. But they have sold for weeks at about 40% below their $97 price at the end of February, shortly before Pathe’s bid surfaced. A separate issue of 13% 1996 bonds closed at $49, up $6.625. One trader said he believed that the sudden jump resulted when an investor was forced to buy bonds to cover a “short” position.

At least one bondholder said he wants Pathe to buy back the bonds, a step that would increase the MGM/UA purchase price to as much as $1.7 billion. “It’s our belief that (the buyout) would violate the covenants. We want to be taken out,” said a representative of the bondholder, who declined to be identified.

Most of the bonds were initially sold to a close circle of customers who dealt regularly with junk bond king Michael Milken.

Among the biggest current holders appear to be First Executive Corp., a Beverly Hills-based insurance holding company, with some $58 million face value in the bonds, and Columbia, with its $38.6 million.

The Resolution Trust Corp., a government agency that administers failing thrifts, has disclosed that it owns MGM/UA bonds with a face value of about $7.4 million. The RTC could also inherit the Columbia bonds if the thrift, which is insolvent, doesn’t find a buyer for its huge junk bond portfolio.

Other buyers of the bonds included Carl N. Lindner’s American Financial Corp., Integrated Resources and other entities that bought frequently from Milken before he was indicted and later pleaded guilty to federal securities law violations. Drexel has closed its securities business and filed for bankruptcy protection.

Spokesmen for Columbia, First Executive and the RTC declined to discuss their holdings in detail.

Some bondholders, however, have said they are concerned that Pathe’s plan to sell its own assets to MGM/UA--in return for some $700 million that would be raised by rights sales to Turner Broadcasting System Inc., Time Warner Inc. and others--may violate a provision limiting MGM/UA’s ability to make payouts to shareholders. They argue that, while MGM/UA is technically buying assets from Pathe, in reality it is creating a payout with money derived from library income that could have been used to service debt.

Once the transaction is complete, Bankers Trust of New York, a trustee for the bonds, is likely to review it for possible violations, a bondholder said.

It appears unlikely, however, that any bondholder would attempt to block the Pathe purchase, which is scheduled to close Thursday, after several delays. Pathe and MGM/UA said Tuesday that they were still waiting for the expected solvency opinion from Houlihan, Lokey, Howard & Zukin Inc., a Century City appraisal firm, before the purchase could be completed.

Some bond experts were skeptical that the holders ultimately could force Pathe and its president, Giancarlo Parretti, to buy out the bonds.

Richard Lehmann, editor of the Defaulted Bonds Newsletter, which is published by the Bond Investors Assn., said there is little recourse available for junk bond holders.

“If you don’t have the protection to begin with, you’re pretty much exposed,” Lehmann said. “The only thing you can do as a bondholder is try to force the new debt to come in behind you. But the chances of doing that are slim, since these were not high-quality bond issues to begin with. “

After an earlier plan to finance the buyout failed in June, some investors bought the bonds, betting that Pathe would never be able to complete the buyout, leaving cash flow from the MGM/UA library to service the bonds.

Last November, MGM/UA bought back about $7.5 million of the 13% bonds on a dip in the market. But investors say they haven’t seen any indication that Pathe will follow suit. “I hope they’ll do it. But they haven’t given any indication of it yet,” one bondholder said.