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Increasing investor concern about use of capital for pumping stock price instead of funding enterprise growth


For other reports of the long term investor interests addressed in the article below, including cited examples and research, see the "Stock Buyback Policy" section of the reference page for the Forum's 2014 Walgreen project.


Source: The Wall Street Journal | CFO Journal, June 16, 2015 article



CFO Journal

3:24 am ET
Jun 16, 2015


Bond-Funded Dividends, Buybacks Draw Skeptics


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 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’s chief financial officer. Ms. Nielsen said the acquisition and the headquarters were “monetizable” in the future.

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, though they are about 8% shy of prerecession levels, on an annualized basis. 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.

Before the recession, companies plowed money into buybacks while share prices were high, but most pulled back sharply during the financial crisis, even as shares plunged. Now, 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 finance chief 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 in a statement that 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. Fund manager Cohanzick Management LLC found the yield on the single-B-minus-rated notes tasty. 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, Cohanzick’s president.

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, and a strong stock price is in bondholders’ best interests. That’s because cash on hand, debt and equity are the three main tools companies use to raise money they want to spend, and sagging shares mean a cash-strapped-company needs to issue more debt, putting existing creditors at risk.


Copyright ©2015 Dow Jones & Company, Inc.


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