reporting and analysis for corporate-finance executives.
Bond-Funded Dividends, Buybacks Draw
Maxwell Murphy and
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
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.