Commentaries

Now raising intellectual capital

Levering up for shareholders

-

TransDigm Group Inc. may not exactly be a household name, but it’s making its mark in the U.S. credit markets as a trail blazer.

The maker of commercial and military aircraft parts raised $425 million in the credit markets this week. But unlike the many companies that have poured into high-yield market to refinance maturing debt, TransDigm had another reason for raising the cash: to pay its shareholders a special dividend.

Such a use of proceeds isn’t unusual during bull markets, but it is striking that a junk-rated company would resort to such behavior so soon after the market meltdown. According to Fitch Ratings, the company’s debt stood at 3x EDITDA before the bond deal , down from 4.2 times at the end of fiscal year 2008 and 5.3 times in the previous year. With the new debt, it shoots back up to 5.0 times, on a pro forma basis.

One deal doesn’t make a trend, but if more companies decide to follow TransDigm’s lead, Fed officials looking for signs of when to pull back on its extraordinary easy monetary policy may want to take notice.

Investors ignore ratings at their peril

-

    Rexam is delivering a nasty surprise to its shareholders, but the logic of its proposed rights issue is hard to fault.
    If trading turns out to be as bad as the board expects, then the penalty payments for refinancing its existing debt will far outweigh the cost and dilution of the issue.
    Broker Oriel Securities reckons the cost to Rexam if it loses its investment grade rating will be an extra 8 to 12 million pounds a year in interest payments.
    Businesses everywhere are rediscovering the joys of equity, as the way to stave off the dreaded downgrade. So far this year, shareholders have put up $119 billion, according to Thomson Reuters data, with $28 billion more due.
    Even cash-rich carmaker Volkswagen is reported to be considering issuing shares to bolster cash reserves and pre-empt any ratings downgrade relating to its merger with Porsche. Spanish utility Iberdrola and French construction groups Lafarge and Saint Gobain all took similar steps to bolster their ratings.
    Unfortunately, credit ratings agencies are so jumpy about regulators and the risks of legal action by investors that companies can’t always bank on such moves working.
    Saint Gobain launched a rights issue, but still S&P cut it to BBB from BBB+. Lafarge did worse. Fitch not only cut its rating to BBB-, it added a “negative outlook”.
    One reason ratings have increased in importance is that as banks have turned off the taps, companies have turned to the bond markets, allowing the agencies like Moody’s Corp and McGraw-Hill’s S&P to cash in.
    Experience has taught them caution, however, and the number of issues downgraded from investment grade to junk is on the rise. The threat of this — with the higher cost of borrowing and reduced market access it brings — is a powerful incentive to go to the shareholders. S&P has identified 75 issuers — with $255 billion of debt — in danger of losing their coveted investment grade.
    The unhappy experience of Rexam shareholders is likely to repeated many times as the debt crisis unwinds, but at least it’s better than losing control of the business to its lenders.

Junk bond market, you’re the only hope

Photo
-

Ok, that may be overstating it, but Fitch Ratings released a report on leverage loan recovery ratings – ie how much loan holders can expect to get back should a company default and the findings are hardly surprising: many investors can expect to get back less than they had thought when they invested in this secured debt.

RR1 means investors can expect a recovery of 90-100%, and RR6 0-10%.

loanrecoveries

A big reason for this is there’s often a lack of unsecured junk bonds below the leverage loans to absorb losses in case of default – another symptom of the boom time.

  •