European firms steer clear of debt-funded share buybacks

Thu Dec 20, 2012 5:46am EST

LONDON, Dec 20 (IFR) - Debt-funded share buybacks, seen as a more aggressive use of bond proceeds, have been the exception rather than the rule in 2012, suggesting that the credit profiles of Europe's investment-grade corporates remain in good shape, S&P says.

Despite near record high-grade bond volumes this year - the highest in a decade with the exception of 2009 - the aggregate value of corporate buybacks has only returned to the post-2001 average.

According to S&P, European companies rated by the agency have completed EUR45bn of share buybacks over the 12 months to the end of November 2012.

Although that is an increase from a 10-year low of EUR12bn in 2009, the past 12 months saw a decline of 31% from 2011 levels, and was nearly two-thirds lower than in 2007 at the height of the last credit cycle when buybacks topped EUR100bn.

According to data from the European Central Bank, share buybacks closely tracked net debt issuance between 1998-2002, but data since 2009 show wider variations and no clear trend.

One DCM banker said there was little evidence that corporates are starting to releverage, adding that many were still flush with cash.

"Since the crisis, corporates have been focused on deleveraging. They remain very focused on having conservative capital structures, and we wouldn't expect to see a sharp rise in special dividends," he said.

"It feels like most companies have pre-funded on the corporate side."

RATINGS SENSITIVITY

Some companies - in particular speculative-grade issuers - have shown a greater propensity to releverage, but on the whole investment-grade issuers remain cautious about the pressure this will put on ratings.

In August, Belgium's largest cable operator Telenet raised EUR700m to buy back shares. Fitch subsequently downgraded the company's long-term issuer default rating to B+ from BB.

Dividend hikes also started to creep back in. In late July, for example, French oil group Total increased its interim dividend by 3.5% to EUR0.59 a share ahead of its second-quarter earnings publication.

The vast bulk of issuers, however, have cut dividends to bolster pressured revenues. They include Deutsche Telekom, KPN, France Telecom and Telefonica.

Companies that have announced share buybacks, including UK-based food services provider Compass, have financed them with free operating cash flow, and their ratings have remained intact.

Similarly, S&P affirmed its BBB rating on Switzerland-based personnel group Adecco, which completed a debt-funded EUR400m share buyback programme in June.

"Although the buyback was funded via a bond issuance, we affirmed the ratings because the company has sufficient flexibility at the current rating to execute the buyback," S&P said.

A small number of high-yield companies have adopted more aggressive debt policies in the form of dividend recapitalisations. These transactions increase leverage to fund payouts to shareholders and in particular to private equity owners which are struggling to sell businesses.

Dividend recaps therefore offer an alternative avenue to extract value from a business, but are not seen as widely representative for the corporate sector as a whole.

Companies that have taken this route include U.K.-based roadside assistance provider RAC Finance and Swedish cable operator Com Hem.

"When it comes to debt-funded share buybacks, the aggregate data show that European corporates have not yet adopted more aggressive financial positions," said S&P.

"That said, with many tipping 2013 to be another strong year for corporate debt issuance, we will monitor this indicator closely."

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