Deleveraging Done in U.S. With DirecTV Rewarding Shareholders
After two years stockpiling cash and trimming debt, Discovery Communications Inc. (DISCA) did what U.S. companies collectively are doing for the first time since the nation pulled itself out of the worst recession in seven decades: It borrowed some more money.
The owner of cable television’s Animal Planet and Discovery Channel sold $650 million of bonds in June that it may use to help fund an increase in stock buybacks, at a yield 0.3 percentage point above November’s record low average of 4.16 percent for companies in the same BBB ratings group. The deal will increase Silver Spring, Maryland-based Discovery’s debt to 2.9 times its earnings before interest, taxes, depreciation and amortization costs, according to Moody’s Investors Service. The measure of leverage is up from 2.6 times before the deal.
Corporate executives are signaling that they’re gaining enough confidence in the economic recovery to begin deploying some of the record $1.9 trillion in cash they amassed after the 2008 credit crisis. By raising debt loads for the first time in almost two years, they’re rewarding shareholders at the expense of bondholders. While DirecTV Chief Executive Officer Michael White is buying back stock, others such as Sealed Air Corp. (SEE) President William Hickey are issuing debt to buy businesses.
“We’ve reached the apex” of credit improvement, said Scott MacDonald, head of credit and economic research at Aladdin Capital Management LLC in Stamford, Connecticut, which oversees about $11 billion. “But I don’t think it’s going to be a rapid decline by any means. If you’re a corporate CEO, you’re sitting here looking out and asking, ‘How aggressive do I want to get?’ And the answer is: ‘Not terribly aggressive.’”
After investment-grade non-financial companies slashed leverage to as low as 1.92 times earnings in December from a peak of 2.2 times in the third quarter of 2009, the ratio has climbed to 1.95 times, the first increase since September 2009, data from JPMorgan Chase & Co. (JPM) show.
DirecTV, the largest U.S. satellite-television provider, and clothing chain Gap Inc. (GPS) led businesses announcing bond sales to fund a 57 percent increase in share buyback authorizations this year from 2010.
Since the end of 2010, 53 percent of non-financial companies in Barclays Capital’s U.S. Credit Corporate index have increased total debt, with less than 40 percent reducing, strategists for the firm led by Jeffrey Meli in New York wrote in a June 3 research note.
Total corporate debt in a JPMorgan corporate debt index rose 3 percent, or $60 billion, to $2.4 trillion in the three months ended March 31 from the final quarter of 2010. Earnings before interest, taxes, depreciation and amortization costs increased 6 percent, or $21 billion, during the same period.
“We’re at a point where companies feel reasonably comfortable with their balance sheets,” Eric Aboaf, Citigroup Inc. (C)’s treasurer, said in an interview. The New York-based bank has more than doubled a measure of its capital and slashed short-term borrowings since receiving a $40 billion government bailout during the crisis.
Growth in average cash holdings by companies slowed to 17 percent from 23 percent a year earlier, Barclays analysts said. Since December, median cash balances declined by 3 percent, they said, “suggesting that while the biggest companies continue to grow cash balances, smaller firms have begun decreasing their cash holdings.”
Companies also are wading more deeply into short-term debt markets that locked up during the financial crisis. Outstanding commercial paper sold by non-financial companies jumped 58 percent this year through July 6 to $191.8 billion, the highest since February 2009, according to Federal Reserve data. The short-term borrowings typically mature within 270 days and are used to finance everyday activities such as payroll and rent.
A measure of leverage that gives greater weighting to short-term debt compared to the market value of a company’s assets, known as market leverage, climbed to as high as 25 on June 13 for non-financial companies, after reaching a more than three-year low of 22.9 in May, according to data from Moody’s.
“This is very typical of the early stages of an economic recovery,” said John Lonski, chief economist at Moody’s Capital Markets Group in New York. “All else the same, you would rather not have companies increase leverage, but given that they’re doing so from a financially stronger position, the increase will not present a material increase in credit risk.”
For bondholders, who have benefited from a 46 percent return since the end of 2008 while relative yields tightened by 5.6 percentage points, the improvement in creditworthiness may be as good as it gets as economic growth slows and Europe’s debt crisis threatens to infect credit markets globally.
The International Monetary Fund cut its forecast for U.S. growth June 17 for the second time in two months, predicting the economy will grow 2.5 percent this year and 2.7 percent in 2012, down from the 2.8 percent and 2.9 percent projected in April.
Bond sales globally have remained below the 2011 average for six straight weeks, according to data compiled by Bloomberg, as Greece’s struggle to avoid a default curbed investor appetite for risk and fueled concern that it could cause a seizure resembling the aftermath of Lehman Brothers Holdings Inc.’s bankruptcy filing in September 2008.
Bondholders are punishing San Francisco-based Gap, the largest U.S. apparel chain, after it sold $1.25 billion of 10- year bonds in April, more than three years after eliminating its long-term debt. The bond sale, which Standard & Poor’s labeled as part of a “somewhat more aggressive financial policy,” may be used to buy back shares.
“Our confidence has grown that we need not be as conservative as we were,” Sabrina Simmons, Gap’s chief financial officer, said in an April 8 telephone interview, saying the company isn’t “going to do anything to jeopardize” its investment-grade credit rating. “We don’t need any more cash to invest in our business because we can do that from the cash we generate. This is an opportunity to bring some leverage onto our balance sheet, lower our cost of capital and perhaps increase our distribution to our shareholders.”
After Gap cut its annual profit forecast by 22 percent on May 19, its $1.25 billion of 5.95 percent notes due in April 2021 fell as much as 5.1 cents to 96.3 cents on the dollar on June 17, according to prices from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The bonds have since risen to 97 cents. The company’s shares have dropped 15 percent this year, rising 11 cents to $18.75 as of 4:15 p.m. in New York Stock Exchange composite trading.
‘Sound Financial Policy’
“Just as we’ve been over the past decade, we are committed to maintaining a sound financial policy, a strong credit profile and a focus on liquidity,” Louise Callagy, a spokeswoman for Gap, said in an interview. While 2011 is a “tough year,” she said, “we expect things to normalize in 2012.”
Bondholders should be concerned that the second-biggest use of borrowed cash among companies increasing leverage was to fund share buybacks and dividend payments, said Meli, Barclays Capital’s head of credit strategy.
Utilities, consumer non-cyclical and basic material companies, all of which both increased debt and decreased cash, had the biggest gains in stock price versus the S&P 500 index (SPX), a trend that he said should give creditors pause.
“The sectors that have increased leverage in aggregate have also been outperformers in the equity market, which is somewhat troubling looking forward for credit investors,” Meli said in a telephone interview. “Pressure on the companies that have not started to do this could grow.”
The biggest increases in debt were at companies closing acquisitions, including Philadelphia-based Comcast Corp. (CMCSA), the cable company that acquired 51 percent of General Electric Co.’s NBC Universal and increased its net debt by $13 billion, according to the Barclays strategists.
After spending about $167 million buying back common stock in the first quarter, Discovery Communications tapped the bond market last month for the first time since May 2010, selling $650 million of 4.375 percent, 10-year notes priced to yield 4.45 percent.
Chief Financial Officer Brad Singer told investors and analysts on a conference call in April that they should expect the company “to deploy more capital at a higher level” than in the past.
“There is a cost of holding cash,” Singer said during a March communications and media conference hosted by Credit Suisse Group AG, noting that the company had already spent more than half of its $1 billion cash hoard since the third quarter. “We are below our current leverage rates than where we would like to be, and so we’d like to put that money to work.”
Discovery Communications declined to comment further, said Michelle Russo, a spokeswoman for the company.
DirecTV (DTV) moved to increase its leverage last year after hiring White to help the satellite-television provider fend off competition from cable and the Web. The El Segundo, California- based satellite-television provider said in May 2010 it’s board had set a target to increase debt to 2.5 times operating profit before depreciation and amortization from about 1.7 times in 2009.
The company said a year later it reached the target after raising a $2 billion unsecured revolving loan to replace an expiring $500 million secured facility, selling $4 billion of notes and repurchasing $6.5 billion of shares in the 15 months ended in March.
Darris Gringeri, a spokesman for DirecTV, declined requests for interviews with executives for this story, instead providing transcripts of conference calls.
“The smartest thing I can do when I got 2 percent or 3 percent after-tax interest cost is to buy back shares,” White, a former PepsiCo Inc. executive, said Dec. 2 at the company’s investor day meeting. “We’re in a unique environment with all- time record low interest rates.”
DirecTV shares have gained 57 percent since White became CEO and are up 31 percent this year in Nasdaq Stock Market trading. They fell 39 cents to $52.42 today.
Sealed Air, the maker of Cryovac food packaging and Bubble Wrap, plans to sell debt to finance its $4.3 billion purchase of Diversey Holdings Inc. as it seeks to expand in emerging markets. Sealed Air agreed to pay Diversey shareholders $2.1 billion in cash and 31.7 million shares of Sealed Air common stock. The purchase also includes $1.4 billion of net debt to be refinanced.
The acquisition will raise the company’s leverage to as high as 5 times its Ebitda from about 2.5 times on March 31, S&P said in a June 1 statement in which the ratings firm put Sealed Air’s corporate credit rating of BB+ on watch for a downgrade.
Credit-default swaps on Elmwood Park, New Jersey-based Sealed Air, which investors use to hedge against losses on the company’s bonds or to speculate on its creditworthiness, have almost doubled since the deal was announced, to 288 basis points.
The swaps, which rise as perceived creditworthiness declines, are trading at levels that imply the company’s debt is rated Ba2 by Moody’s Investors Service, a speculative-grade ranking that’s two steps below its actual rating of Baa3, according to Moody’s capital markets research group.
Other companies are asking how much additional debt they can take on without having their credit grades lowered, said Rizwan Hussain, a strategist at Morgan Stanley in New York, a signal that they may face pressure from shareholders to capitalize on such a low cost of capital, he said.
Their thinking may be that “my shareholders are going to be very upset at me if at some point down the road I didn’t access this cost of capital,” Hussain said. “Because if I didn’t, it’s inherently admitting I don’t have any great investment opportunities I can get over that very low hurdle.”
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