Investors resigned to funding stock buybacks
NEW YORK, Feb 28 (IFR) - Investors are turning a blind eye to shareholder-friendly activity by borrowers, as ballooning portfolios make the once heated topic of leveraging up to buy back stock a barely acknowledged risk when it comes to pricing bonds.
In the past week close to USD30bn of orders poured in for USD10.35bn of bond issuance by Cisco, PepsiCo and Juniper Networks.
The three corporates came to market either to raise funds for share repurchases or, in Pepsi's case, to pay down commercial paper ahead of what analysts expect will be more CP issuance to help pay for its planned USD8.7bn buyback and dividend payout to shareholders this fiscal year.
Traditionally, the sight or threat of a company increasing leverage for shareholder-friendly purposes would have sounded alarm bells, or at the very least required issuers to pay up for new debt.
But that was not the case for Cisco, which priced USD8bn in a seven-tranche deal with zero to just 5bp of new-issue premium; nor for Pepsi, which raised USD2bn of threes and 10s 2bp-4bp inside comparables; nor for Juniper, Cisco's smaller competitor, which issued USD350m of 10-year notes more than 12bp tighter than secondaries.
"It has gotten to a point where it's commonplace for bonds to not require too much new-issue concession to compensate for things like [shareholder-friendly actions]," said Scott Kimball, senior portfolio manager at Taplin Canida & Habacht, part of the BMO Global Asset Management group.
For investors, the biggest concern is whether a capital return to shareholders could cause a downgrade. But in today's market, that downgrade has to be a dramatic one that involves dropping out of a rating category altogether for it to raise red flags.
"Generally, if a company keeps its ratings in the same ratings category [a downgrade] isn't that big of a deal and many investors will look the other way," said Michael Collins, senior portfolio manager at Prudential.
Most of the six share-repurchase related negative rating actions taken by Fitch on US corpoates last year were in the triple-B rating category, compared with a single-A/double-A dominance of similar negative rating actions in the previous two years.
"This highlights the fact that even triple-B rated issuers currently face little cost in terms of market access or borrowing rates from moving one or two notches down the rating scale," said Philip Zahn, senior director in corporate ratings at Fitch.
With bond mandates for refinancing slowing, underwriters in the high yield market are also pushing the leveraged share buyback idea hard, and especially while they can point to yields near record lows and interest rate stability.
But in high yield, investors can at least ask for greater protection than what's available in investment grade.
"In a market like this where shareholder activism is so prevalent, we think bond covenants are really important," said Stephen Kotsen, a high-yield portfolio manager at Nomura Asset Management.
Some analysts warn that Pepsi might sacrifice a notch in rating if activist Nelson Peltz succeeds either in securing even greater capital returns than the company is already committed to, or even in forcing a break-up of its snack and beverage businesses.
"With a goal of maintaining Tier 1 commercial paper access, we think PepsiCo can push the limits on its shareholder-enhancement plans and sacrifice its A1 senior unsecured rating at Moody's to target a mid A senior unsecured rating profile," said Edward Mui, a credit analyst at CreditSights.
But having received nearly USD18.5bn of inflows so far this year, investment-grade fund managers can justify taking on a stellar brand name and infrequent issuer such as Pepsi, downgrade and break-up threat or not.
"People are sitting on so much cash right now that I think in terms of all of the possibilities of potentially negative news that could occur with a company, leveraging up for share buybacks is not quite as punitive as a major acquisition - or, worse, an LBO," said Steven Oh, head of global credit and fixed income at PineBridge Investments.
But what has made funding cheap for share repurchases has also heightened the potential for acquisition-event risk, argues Kimball.
"There's a disconnect as to how people are perceiving risk," he said. "Just because corporate America has a lot of cash, cheap financing and all that good stuff, doesn't mean the risks have decreased. What if the share buybacks don't do enough and stock prices continue to slump?
"The point is that only looking in the rear-view mirror does you no favors. You have to worry about what the company will look like three years from now and make sure you are getting paid appropriately today for the risk."
For the moment, however, it appears that as long as they have some clarity on the magnitude of shareholder agitation, investors are willing to come in to bond issues.
A crucial reason for the deluge of orders for Juniper's deal, meanwhile, was the fact that it had swiftly bowed to activist pressure from Elliott Management the week before, by agreeing to a plan to return USD3bn of capital over the next three years.
"Bond investors hate not having clarity, so if a borrower gives them that, then they will be fine, because they can work out valuation," said one banker.
Keeping the deal small helped to drive in that valuation. A banker close to Juniper said the firm had decided to raise only USD350m to supplement cash on hand set aside to pay for a USD1.2bn accelerated share repurchase that is part of the capital return plan's USD2bn of stock buybacks.