The Great American Debt Dietby
Call it the Great American Workout, corporate style. After a decade-long debt binge, companies are finally beginning to ease the burden. A flock of big-time borrowers--including Time Warner, RJR Nabisco, and Goodyear Tire & Rubber--have gone to market in recent weeks to reduce their leverage. It seems that everyone is shedding the unwanted weight.
At a time when the economy remains shaky, that's a bit of good news. Until recent months, layoffs, asset sales, and plant closings were the only way highly leveraged companies could ease their crushing balance-sheet pressures. Now, the lowest interest rates in years and a voracious stock market have provided cash for productive investment. The result: the first real chance in years for companies to seize new business opportunities and expand. And with that, the nation may be on the road to a long-awaited improvement in corporate profits. "Companies are breathing a sigh of relief," says Richard Kopcke, a vice-president at the Boston Federal Reserve Bank. "They won't rush out and make lots of new investments. But they may want to set themselves up to take advantage of the future."
Many companies are issuing new equity to retire old debt (chart). Tyco Toys Inc. of Mt. Laurel, N. J., falls into that category. It sold $52 million worth of stock to clear away junk bonds issued in 1988 and 1989. Others are swapping 1980s high-yield bonds for new ones, often knocking three or four percentage points off the interest rate they must pay. Some companies are trying to eliminate enough debt to shake the regulatory label "highly leveraged," which these days is anathema to banks. Even some companies that can't lower their rates are ditching bank debt for bonds to gain longer maturities and more tolerant public investors.
Feeding the market's appetite for new stock are companies that went private in leveraged buyouts. On Oct. 15, Owens-Illinois Inc., the glass bottle maker acquired in 1987 by Kohlberg Kravis Roberts & Co., announced it would go public again with a stock issue of up to $1 billion. And the LBOs that flopped? Their investors are getting new paper, too--usually preferred stock or lower-yielding bonds. "What's going on is a massive restructuring," says Barry Ridings, a managing director at Alex. Brown & Sons, a Baltimore brokerage house. "The market is eating it up."
The refinancing boom is still picking up steam, but the results are already striking. Securities Data Co., a Wall Street information service, estimates that more than $18 billion in new paper was sold in 1991's third quarter for the principal purpose of retiring debt.
WELCOME TREND. The deals are easing the burden of debt service on the economy. Last year, interest payments sucked up more than 40% of the cash flow of the nation's nonfinancial businesses. That figure is down to 35% in this year's second quarter, the lowest level in two years (chart). In all, companies cut interest payments by $6 billion in the first six months of this year.
The balance-sheet refurbishment, says David Resler, chief economist for Nomura Securities International Inc., is a welcome trend that hasn't peaked yet. "This is the first phase of a significant balance-sheet restructuring that has to take place in the next few years," Resler says. But, he warns, the debt diet won't give the economy the jolt it needs unless interest rates keep dropping.
A fundamental change in investor behavior could help keep rates on the right course--and promote the refinancing wave. As short-term rates drop, individuals have been abandoning money funds and certificates of deposit in favor of riskier but higher-yielding corporate bond funds. As much as $400 million a month is flowing into the funds. It's the same with equities. Individual investors seem to be moving back into the stock market for the first time in years. If the market rally continues, investors may spend some of their capital gains, further juicing up the economy.
Where the cash comes from doesn't matter much to chief financial officers. They're just happy to get it. "There are lots of growth opportunities out there," says H. Neil Campbell, CFO of Dallas-based Republic Health Corp. "We need to have the capital to take advantage of them." Republic hopes to use the cash flow gained through refinancing to build or acquire additional hospitals.
Republic was a classic LBO flop. It borrowed $556 million in 1986 and was in bankruptcy by 1989. Yet, on Oct. 15, Republic was back in the market with a massive restructuring that includes the sale of $55 million in equity to the Joseph Littlejohn & Levy Fund, a private investment partnership, and 3 million common shares to the public. The package will cut Republic's cost of capital by only about half a percentage point, but the reduction in overall leverage will halve its annual debt service to around $20 million.
The big players are deleveraging, too. Goodyear Tire & Rubber Co. loaded up on debt in 1986 in its successful effort to fend off a takeover attempt by Sir James Goldsmith. But the cost of that victory was high -- last year, Goodyear paid $328 million, or more than half of its cash flow, in interest. So, on Oct. 1, the nation's biggest tire producer announced it would sell at least 10 million new common shares. The offering should cut Goodyear's annual interest cost by nearly $28 million. And the financial cleanup should help Goodyear focus on a big new marketing effort.
Then there's RJR Nabisco Inc., the giant of the 1980s debt binge. The company is raising $1.9 billion from the sale of common and preferred stock. RJR still has a staggering $16.4 billion in debt on its books, but its new offering should reduce its debt-to-capital ratio from 80% to near 60%. The company's cost of funds could be reduced by up to two percentage points, and it may be able to slash its interest payments by $250 million a year. RJR plans
to push tobacco exports with the windfall. Says CFO Karl von der Heyden: "We had to have the financial flexibility to move quickly in emerging markets such as Eastern Europe and Mexico."
CRAWLING OUT. RJR was the kind of company that came to mind when analysts were predicting the worst as the 1980s junk-bond bubble grew. A recession, the gloomsters feared, would squeeze cash flow, throw hundreds of highly leveraged companies into default, and plunge the markets into chaos. The result: A normal cyclical downturn would turn into an economic rout.
Instead, companies today are slowly crawling out from under their debt service. "We may have a Rube Goldberg system," says IDS Financial Services Inc. chief economist William Melton. "But it adjusts. All these distortions always get adjusted." It hasn't been pretty, but Corporate America is finally getting its balance sheet back in shape.