29 Aug, 2024
IT, communications bankruptcies projected to reach multiyear high in 2024
By Iuri Struta
Bankruptcies in the information technology and communications sectors are on the rise this year, driven by a combination of heightened interest rates and industry-specific challenges.
Tech companies that focused on aggressive growth during the zero-interest era before 2022 are facing a reality check. As interest rates have risen, many that struggled to adapt to the changing market dynamics have been compelled to shut their doors.
Bankruptcies in the IT and communications services sectors are projected to reach a five-year high in 2024, given the number of bankruptcy filings from those two sectors through July of this year combined with historical averages for the last five months of prior years. This year is likely to see more than 50 bankruptcies from those two sectors, the highest since 2019. Focusing solely on the IT sector, the numbers suggest that bankruptcies could soar to a 12-year high.
"When there is a lot of capital available, managements can keep funding losses to keep things going. With rising interest rates, it has been harder to get capital and financing has been more expensive," said Dennis Twomey, partner in the corporate restructuring unit of Sidley Austin, in an interview with S&P Global Market Intelligence.
Sector challenges
While many of the companies that filed for bankruptcy this year pointed to rising interest rates as the primary reason behind their need for reorganization, some sector-specific challenges have emerged in the wake of the pandemic.
So far this year, at least six telecom operators declared bankruptcy. For some of these, the anticipated opportunity of private 5G networks did not pan out, prompting companies such as Casa Systems Inc. and Airspan Networks Holdings Inc. to declare bankruptcy. Both Casa Systems and Airspan Networks had liabilities of more than $100 million.
The business communications market has also struggled with weakening demand and heightened competition post-pandemic. Microsoft Corp.'s Teams, a collaboration application launched in 2017, has emerged as a market leader with more attractive pricing and bigger distribution channels than business communications specialists like Zoom Video Communications Inc., 8x8 Inc. and RingCentral Inc. The equity markets also reflect concerns about these more narrowly targeted businesses, as the stocks of Zoom Video, 8x8 and RingCentral are all trading at multiyear lows, even as the overall market has rallied.
There have been multiple bankruptcies in the business communications segment in the past 18 months. IT services company ConvergeOne Holdings Inc. filed for bankruptcy this year, partly blaming disruptions from its key partner and supplier Avaya Holdings Corp.
Avaya, a cloud communications and workstream collaboration services company, itself filed for bankruptcy in 2023 after it faced challenges shifting its business offering to a cloud-based model.
Meanwhile, Telefonaktiebolaget LM Ericsson (publ) has written down the value of its $6.2 billion 2022 acquisition of Vonage Holdings Corp. by nearly $4 billion.
Another notable trend this year is an increase in the number of large bankruptcies by private equity-owned companies.
Four PE-owned companies with liabilities of more than $500 million have filed for bankruptcy this year, including electronic controls and switches manufacturer Robertshaw US Holding Corp., marketing technology firm Dynata Holdings Corp., telecoms analytics software vendor Mobileum Inc., and the aforementioned ConvergeOne.
Last year, only one PE-owned company with assets over $500 million filed for Chapter 11.
A number of these bankruptcies were the result of unsustainable debt levels.
"A lot of bankruptcies in the last 12–18 months have involved sales of the businesses rather than internal organizations. With a lot of these, parts of the businesses survive. That is a common outcome when the company has too much debt," said Sidley Austin's Twomey.
The rise of LME
The number of bankruptcies could have been significantly higher if not for liability management exercises. These strategies allow companies to leverage weak debt covenants to safeguard their assets from creditors. Following its merger with DISH Network Corp., EchoStar Corp. pursued this tactic by moving its assets into unrestricted subsidiaries and initiating debt exchanges for some of its convertible and unsecured notes. Unhappy creditors filed a lawsuit alleging the move was illegal. The case remains ongoing in the US District Court for the Southern District of New York.
"These LME transactions are occupying much of the restructuring space right now," said Robert Stark, chair of Brown Rudnick’s bankruptcy and corporate restructuring department, in an interview with Market Intelligence. "The growing number of LMEs are made possible, in part, by weak covenants contained in the more recent vintage of loan documents."
It would not be surprising to see the pace of bankruptcies in the tech sector going up in the coming months and years. After venture capital dried up in the second part of 2022, many startups resorted to debt funding, mostly issuing non-convertible notes, which are more secure than convertible notes.
According to S&P Global Market Intelligence data, debt deals represented about 5% of all funding activity in 2021. That number started to rise in the second half of 2022, reaching 43% in the third quarter of 2023, and remained high in the following quarters.
The rise in debt raises comes at a time when revenue growth in the software industry has decelerated in the last few quarters, putting additional strain on firms lacking a strong business model.
