Deals

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

(Updated )

AT&T is officially acquiring entertainment-media giant Time Warner, at a price of $108.7 billion including net debt. The goal here sort of makes sense: AT&T has the distribution network and it wants the content of Time Warner, parent of HBO, CNN and TBS.

But AT&T's debt may balloon to levels that would put it at risk of a downgrade. That's a significant concern for both AT&T, the second-largest U.S. wireless carrier, and the broader $8 trillion corporate-bond market, considering that this company already had more than $120 billion of debt outstanding.

Broad-Bond Provider
Wireless carrier AT&T is the biggest issuer of U.S. non-financial corporate bonds
Source: Bank of America Merrill Lynch index data

Let's put that debt load into context. It's more than any other non-financial issuer in the U.S. corporate bond market and more than four times as much as the biggest U.S. junk-bond seller.

At a minimum, any downgrade would dent the value of AT&T's debt and send its borrowing costs higher. So what would it take for that to happen? Its current rating is BBB+ at S&P, three levels above junk, after being cut in 2015 in the wake of its $18.2 billion purchase of AWS-3 wireless spectrum licenses. AT&T has said it wants to reduce debt to regain its higher rating, but this deal very well could move it in the opposite direction. 

Dialing It Up
AT&T has demonstrated a willingness to risk its credit standing to grow through large acquisitions
Source: Bloomberg

AT&T is paying $107.50 a share for Time Warner, half in cash and half in stock (with the stock portion subject to a collar). To supplement the cash on its books -- only about $6 billion -- AT&T is borrowing billions of dollars in additional debt. Net debt could potentially surge to nearly three times the sum of the Ebitda that AT&T and Time Warner were each forecast to generate next year on their own. Any higher than three times Ebitda could be enough for a downgrade, according to a recent S&P Global Ratings report.

AT&T is already nearing its leverage limits for its current rating at Moody's, so a material increase in debt over Ebitda will put it at risk for a downgrade at that credit-rating company as well. AT&T said in its statement Saturday announcing the merger that it expects net debt to adjusted Ebitda to be in the 2.5 range in the year after the deal closes, without saying what the adjustments would be.

Debt Load
Some back-of-the-envelope math shows that AT&T's leverage ratio could surge back to nearly 3 times unadjusted 2017 Ebitda
Source: Bloomberg
*AT&T's net debt before the deal plus half the Time Warner purchase price

Because half the purchase price is made up of AT&T's equity, its overall leverage ratio won't climb nearly as much as if the carrier had used all cash. Still, this could be a disruptive development for the market at a time when investors are pouring near-record amounts of cash into U.S. corporate bonds. Just last year, a Moody's downgrade of Sprint, the biggest U.S. junk-bond issuer, sparked a tumble in that wireless carrier's debt and sent jitters through the high-yield market, showing how unsettling it can be when a dominant corporate-bond seller's rating is cut.  

In Sprint's case, it was already junk-rated. Were AT&T to lose its investment-grade status, that could trigger more disruption as some bondholders can't hold high-yield debt and would be forced to sell. AT&T still has a fairly long way to fall before it loses its high-grade status, but a massive deal like this needs to be monitored closely by credit investors to make sure that it's creating more value than it's destroying.

Investment-grade corporate bonds are poised for their best annual performance since 2009. Going forward, it's idiosyncratic events like this that may drive whether the investments remain winners or turn into losers.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Updates story that was first published  Oct. 21 with final deal terms.)

To contact the authors of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net