Why Business Is Crazy for Debt

Low rates, troubled balance sheets, hungry investors, and fears of war spur a corporate borrowing binge

The sluggish economy was hitting Crown Cork & Seal Co. (CCK ) hard. More than half of its $4 billion in debt was coming due this year, but its low share price ruled out raising money by issuing more stock. The Philadelphia company already had raised the prices of the aluminum cans it makes for everything from soda to aerosol, and spun off a top business, but that was far from enough. Then it found a way out.

On Feb. 11, Crown issued $2.1 billion in 8- and 10-year bonds in the country's biggest junk-bond deal in three years. Investors snapped up the debt, which carries rates from 9 1/2% to 10 7/8%, giving the company some badly needed breathing room. "Now we can concentrate more on running our business," says Alan W. Rutherford, Crown's vice-chairman and chief financial officer.

Corporate America is issuing debt faster than a tapped-out sailor on shore leave. Companies sold $103 billion in bonds in the first eight weeks of this year--up 26% from the same period last year. Only 13 years ago, U.S. companies didn't sell $100 billion in bonds in a year. And the bond bonanza might top 2001's record $738 billion. Already, General Electric Co. (GE ) issued $5 billion in 10-year bonds on Jan. 21. Goldman Sachs Group (GS ), J.P. Morgan Chase (JPM ), Citigroup (C ), and other investment banks have raised $38 billion in bonds for themselves, vs. $23 billion a year ago. "It's the only game in town," says Richard J. Peterson, chief market strategist at Thomson Financial Corp.

Despite their rush to issue bonds, companies aren't digging themselves much deeper into debt. Most of the proceeds are earmarked for refinancing their old debt. And companies are seizing a chance to retool their balance sheets by locking in the lowest interest rates in years: For example, top-quality five-year bonds now pay 1.4 percentage points less than they did a year ago. Other companies are replacing short-term debt with long-term financing that may cost more--a top-rated 30-year bond will pay roughly 2.45 points more than a five-year bond--but protects them against rate increases that would jack up their future borrowing costs.

A lot more than routine refinancing is taking place. Indeed, many chief executives now consider restructuring their debt a critical mission, especially as investors increasingly scrutinize companies' credit profiles in the wake of fiascos such as Enron Corp. and WorldCom Inc. As a result, says Thomas J. Gahan, head of corporate finance in the U.S. for Deutsche Bank, "Debt has gone from being a commodity product to a strategic tool for management."

Many of the companies rolling over their debt would rather be reducing it, but they can't get cash any other way. Hiving off unwanted businesses won't work because buyers won't come out of hiding until the sour economic climate improves. And with stock markets still in the doldrums, most companies don't want to sell new shares at giveaway prices. So far this year, companies have issued 6.5 times as much debt as equity--nearly double the average of the last 30 years and the highest since 1984, according to Goldman Sachs.

The bear market is spurring investors to look for higher returns with relative safety. That's feeding the huge demand for bonds, and in turn making it much easier for companies to sell them. A record $140.5 billion in new money rushed into bond funds last year, a 60% increase from 2001. Even a tottering giant such as Tyco International Inc. (TYC ) chose to issue new debt rather than float new shares in a bear market or sell assets at fire sale prices because it could easily sell its bonds. In early January, it raised $4.5 billion to plug a $3.6 billion hole in its balance sheet. Troubled Qwest Communications International Inc. (Q ) also plans to go to the bond market. On Feb. 19, Vice-Chairman and Chief Financial Officer Oren G. Shaffer said the company is looking at doing more debt-for-debt swaps.

For companies that are saddled with debt from big mergers, refinancing with longer maturities buys them time to strengthen their balance sheets. On Jan. 10, Comcast Corp. (CMCSA ) issued $1.5 billion in 7- and 12-year bonds to pay off part of its debt from purchasing AT&T's (T ) broadband business in November. "It is of utmost importance to us to continue to improve our [credit] standing," says William E. Dordelman, who is Comcast's vice-president for finance.

The rush to issue bonds is partly driven by a worry that investor appetites may wane if war breaks out in Iraq. In that case, some investors may park their funds in even safer havens, such as Treasuries. "A lot of companies have accessed the debt markets to get ahead of a potential market disruption," says Jeff Schroeder, managing director and co-head of credit capital markets at Goldman Sachs.

That's a smart move. If a war ends quickly and the stock market looks as if it's rebounding, investors may move out of bonds and back into stocks. Besides, companies may face stiffer competition for capital in the spring: An estimated $607 billion in debt matures this year--the average since 1999 is $56 billion less--and a hefty chunk of that must be refinanced in March and April.

The stubbornly high level of corporate debt--even if it's rising only slightly this year--means that companies may have an even tougher time paying it down if the economy doesn't pick up. Already, debt makes up 76.5% of the net assets of nonfarm, nonfinancial corporations, vs. 70% in 1999. Meanwhile, ratings agency Moody's Investors Service is downgrading five investment-grade companies for every one it raises. And, since 1998, the percentage of investment-grade corporate bonds hovering one notch above junk status has jumped from 30% to 45%, the highest level since Merrill Lynch & Co. began keeping track in 1988.

The strains are beginning to show as companies try to sidestep a possible financing crunch by, for example, slowing down capital investments. "Corporations have little choice but to use their cash flow to pay back debt rather than increase capital expenditure," says David Bowers, chief global investment strategist at Merrill Lynch. "They are being run to generate cash instead of growth."

Many bankers, however, are optimistic. They believe that when the economy and stock market revive eventually, companies will decide it's time to clean up their balance sheets for real by issuing equity. "There will be a lot of business for investment bankers," predicts Marcel Ospel, chairman of UBS. And after that, companies like Crown, Cork & Seal can start putting the fizz back in their businesses.

By Emily Thornton, with Diane Brady in New York

— With assistance by Diane Brady

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