The Tightwads Are Running The Show NowLarry Light
"High leverage" is a term no longer acceptable in polite society. With the stock and bond markets hitting new highs, companies by the hundreds are scrambling to deleverage, by floating equity issues to retire debt or by replacing debt with lower-coupon paper.
Unfortunately, a far greater number of companies remain walled off from fresh capital. They include many large companies with problematic balance sheets and most of the 90% of Corporate America with below-investment-grade pedigrees. Banks, shell-shocked from billions of dollars of bad loans, are the most stingy lenders. But insurers, mutual funds, overseas investors, and other capital sources have also sharply cut back their lending (chart) to borrowers other than prime credits. All of this spells trouble for the 1990s, for below-investment-grade companies are the employers of most Americans and are often the incubators of tomorrow's growth.
For chief financial officers, the lesson is clear: Access to capital is emerging as the crucial factor in corporate success. The business world is dividing up into two tiers: those companies that can get capital and those that can't. Those that can't are usually the ones that need it most.
PATCHING CRACKS. Consider a tale of two credits: USG Corp. and Hershey Foods Corp. USG, the nation's No. 1 wallboard maker, fended off a raider in 1988 by pumping debt up to a backbreaking $2.6 billion, paying yearly interest rates as high as 16%. When the housing market fell apart, so did the Chicago gypsum-producer's ability to pay the horrendous interest tab. With the company deep in the red, no one will lend or invest another dime. To keep the company from falling into bankruptcy, Chief Executive Eugene B. Connolly is forced to perform the sad 1990s ritual of begging creditors to exchange their bonds for lower-paying paper or for the nearly worthless stock.
Hershey is everything USG is not. The candy and pasta company's profits are undented by the recession. With its sterling credit rating, Hershey in February easily floated a $100 million bond issue paying 8.8% and is using the money to build two new plants. Says Chief Financial Officer Michael F. Pasquale: "There's no credit crunch for me."
Spooked by the surge in business failures, capital providers have seldom been so choosy. In every recession, of course, they tighten up their standards and won't deal with risky operations. This time, though, they're tougher, refusing financing to almost anyone who has too much debt. More ominously, they intend to stay tightfisted long after the recovery comes. Says Frank V. Cahouet, chairman of Mellon Bank Corp.: "A whole segment of companies won't get financing and will atrophy. You'll have to wait four years for this to loosen up."
FOREIGN FALL-OFF. Banks are the most prominent skinflints. Regulators have pressured them to avoid highly leveraged borrowers. Alarmed that a continued slump will blight his reelection campaign next year, President George Bush is trying to get federal bank examiners to ease up. But even if they comply, it's doubtful that will spur much more lending. Reason: The banks can't afford to take on new ventures because their own financial performance is hurting.
The tightwad ethic is as strong among the less regulated institutions, such as insurers and mutual funds. Consider how they've shied away from one of their favorite vehicles: private placements, which are direct purchases of securities from companies that usually are small and less creditworthy. Those fell 27% in 1990 and this year are expected to slide 8% more.
Even overseas investors, who have long favored the U. S. as a stable and easily accessible place to put money, are thinking twice. For the first half of 1991, foreign investment in American companies was a mere $7.6 billion--less than a third the level for 1990's first half. Compared to the 1980s, that's pitiful: Overseas investment in the U. S. peaked at $71 billion in 1989. "Those days are really gone," says David G. Strongin, director of international investments at the Securities Industry Assn. trade group. A cheap dollar should make U. S. investments attractive. But while a few foreign money mavens are investing in U. S. institutions, most are preoccupied with problems at home. Japanese investors are pinched by their wobbly stock and real estate markets. Europeans are busy fighting their own recessions, getting ready for the falling of trade barriers on the Continent next year, and helping privatize Eastern Europe.
Initial public offerings of stock may have become popular lately, but a lot of companies still are shut out of the IPO party. High-tech, health care, and specialty retailing are hot; steel, chemicals, and publishing are not. Especially if a lot of debt is on the balance sheet. That was the fate of Multi-Local Media Corp., a heavily indebted publisher of regional yellow-pages directories that sought to raise $60 million in the stock market last April. The Rockville Centre (N. Y.) publisher had shown three years of solid growth, and it had big plans for the future. Still, buyers were willing to pay only a fraction of Multi-Local's $11 asking price, and the company pulled the offering.
None of this means that investors and bankers are keeping their wallets shut for all comers. Even some highly leveraged enterprises can get cash or capital--as long as they happen to be companies such as RJR Nabisco Inc., whose recession-resistant consumer products deliver a torrent of cash flow.
CRUISING ALONG. Goodyear Tire & Rubber Co., the country's top producer of tires, doesn't enjoy such a bountiful cash flow. But analysts still feel it will be able to raise the $423 million it's seeking in a stock offering to ease its hefty debt burden. Wall Street likes the company's earnings potential under its highly regarded new CEO, Stanley C. Gault. The fresh capital would reduce Goodyear's 66% debt-to-capital ratio. "Our goal is to get below 50%," said CFO Oren G. Shaffer before the offering.
Some less standard sources of financing are emerging to serve credit-starved companies. Several new investment pools take minority positions in promising new middle-market companies that aren't ready yet to do an initial public offering. Lawrence C. Tucker, a partner at Brown Brothers Harriman & Co., says his firm's 1818 Fund looks for "a sector with promise and good management, which also has a sizable equity stake."
Commercial finance companies also are leaping into the breach. Their lending activity has shot up almost 30% from last year. Their loans usually are secured by the borrower's plant and equipment or by accounts receivable. The downside is that these loans are often of shorter duration than bank borrowings--2 to 3 years vs. 7 to 10--and cost more, often two percentage points.
Another financing source enjoying a boom is barter, which allows cash-short companies to swap goods and services. Since 1989, these deals have climbed 15%. While the appetite for barter is limited in America's cash-based economy, this is a way to save money at the margin--up to about $1 million per deal. Icon International Inc., a New York barter firm, arranges exchanges of broadcast ads for items ranging from hotel rooms to root beer.
These capital providers will ease the pain for thousands of companies shut out of conventional markets. As the economy recovers, mainstream lenders and investors will become more forthcoming. Still, the near-term prognosis echoes that old anticapitalist Karl Marx: The rich will get richer, and the small or highly leveraged will have to fight to survive.