(FROM THE WALL STREET JOURNAL 6/16/15)
By Maxwell Murphy and Mike Cherney
As investors size up the potential risks and returns of
corporate bonds, some are keeping a closer eye on a new concern:
what the company plans to do with the proceeds.
Companies typically offer bonds to fund acquisitions, invest in
their businesses or refinance debt. But a growing number are using
them to fund dividends and stock buybacks.
That's raising some eyebrows, particularly in the high-yield
bond market, whose noninvestment-grade borrowers already carry
sizable debt loads.
"It's something that we're watching," said Putri Pascualy, a
portfolio manager at Pacific Alternative Asset Management Co.,
which oversees about $9.7 billion in assets. "In terms of an
orange-level alert, or a red-level alert, I think we're at an
orange level."
This year at least 10 junk-rated companies or their affiliates,
including satellite radio operator Sirius XM Holdings Inc., hot-dog
chain Nathan's Famous Inc. and publisher McGraw-Hill Education,
issued more than $5.4 billion in debt at least in part to finance
dividends and buybacks. That's on top of the 30 companies that
issued more than $14.8 billion of high-yield debt for those
purposes last year, according to Standard & Poor's Leveraged
Commentary & Data.
"I've passed on fairly levered high-yield issues that have done
dividend deals to extract equity," said Arne Espe, senior portfolio
manager at USAA Investments, which manages some $68 billion in
mutual funds. He declined to identify the offerings.
"If you're looking at debt in general, you like to see something
done that benefits the long term," said Aaron Izenstark, chief
investment officer of IRON Financial, which manages $2.5 billion of
assets. "I don't know that you can say that about borrowing money
to repurchase your own stock."
Some companies are continuing to invest for the long term. Coach
Inc.'s shares tumbled by a third last year amid a 10% drop in
sales. The handbag and accessories maker had no long-term debt, but
in March it issued $600 million of bonds debt to fund its purchase
of upscale shoemaker Stuart Weitzman and invest in a new New York
headquarters.
"We are much more focused on 'how do we invest in the
business,'" said Jane Nielsen, Coach CFO.
Companies in the S&P 500 index paid a record $93.4 billion
in dividends last year and repurchased $148 billion in shares in
the first quarter, according to S&P Dow Jones Indices. Buybacks
are also on the rise. Goldman Sachs Group Inc. predicts index-wide
buybacks will hit a record above $600 billion this year and will
represent 28% of companies' total cash spending.
Investors are often most concerned when closely held,
lower-rated companies issue debt to pay dividends to their
private-equity owners, such as single-B-minus-rated McGraw-Hill
Education, which issued debt to pay Apollo Global Management LLC.
An Apollo spokesman declined to comment.
The healthy economy and ultralow interest rates have made many
investors so eager for yield that they overlook a company's plans
to spend bond proceeds on buybacks and dividends, which don't have
the potential to improve a company's business prospects.
Debt-laden companies might get a pass if their business is
performing well. Bondholders also tend to give latitude to highly
rated companies with big cash piles overseas that want to return
capital but issue debt, instead of paying additional tax to bring
the money home.
But bond investors have less patience for companies with weaker
balance sheets and less-stable cash flows. These junk-rated issuers
now have $1 in cash for every $7 in debt, according to S&P.
Sirius XM Chief Financial Officer David Frear said Sirius, which
has a double-B credit rating, has issued $2.5 billion of high-yield
debt since last May and bought back $5 billion in shares over the
past two years. He said he hasn't run into concerns from
bondholders, and that adjusted earnings and cash flow after capital
spending each jumped by 60% or more during the company's
repurchases.
Nathan's Famous in March issued $135 million in notes maturing
in 2020 to pay a special dividend equivalent to 35% of its stock
price. Thanks to an 18-year deal with a unit of meat processor
Smithfield Foods to make its hot dogs, Nathan's is guaranteed a
revenue stream that covers its annual interest payments.
"They were capitalizing future earnings in a very tax-efficient
way," because the interest payments will lower taxable profits,
said David Sherman, president of Cohanzick Management LLC.
Ronald DeVos, Nathan's CFO, had no comment.
Some CFOs think the worries about bond-funded dividends and
buybacks are overblown, even if capital returns don't improve the
business.
Debt analysts "hate" companies' practice of using debt to fund
buybacks, said Pete Nachtwey, CFO of asset manager Legg Mason Inc.
"I think sometimes they're a bit myopic," he said.
Repurchases can help drive share prices higher, or prevent them
from dropping, Mr. Nachtwey said. Sagging shares mean a
cash-strapped-company needs to issue more debt, putting existing
creditors at risk.
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