A wave of expected major-media mergers would transform
AT&T Inc. and Comcast Corp. into the two most indebted companies in the
world, a standing that carries uncharted risks for investors in the firms’
bonds.
If both deals are finalized—AT&T has bought Time Warner
Inc. and Comcast hopes to purchase 21st Century Fox Inc.—the companies will
carry a combined $350 billion of bonds and loans, according to data from
Dealogic and Moody’s Investors Service. The purchases are meant to provide
additional income to help the acquirers to weather turmoil sweeping their
industries. But if the mergers falter, the record debt loads will give AT&T
and Comcast little margin for error, fund managers and credit ratings analysts
say.
“It’s a very big
number,” said Mike Collins, a bond fund manager at PGIM Fixed Income, which
manages $329 billion of corporate debt investments. “It has fixed-income
investors a little nervous and rightfully so.”
The debt-fueled buyouts by AT&T and Comcast are extreme
examples of a decadelong surge in corporate borrowing that is stoking investor
anxieties about what will happen as the economy slows and global interest rates
rise. The ratio of debt to corporate earnings, commonly called leverage, has
also risen, giving companies less financial cushion to absorb market shocks.
Global corporate debt excluding financial institutions now
stands at $11 trillion, and the median leverage for such companies rated
investment-grade has jumped 30% since the eve of the financial crisis in 2007,
according to Moody’s research. Most companies issue new loans and bonds to
repay debt, and investors are concerned about how companies will refinance
their record-breaking debt loads when capital markets experience their next
significant downturn.
Officials at AT&T and Comcast say the refinancing risk
from their post-deal debt would be minimal because they plan to quickly repay
much of the debt with cash generated from the combined businesses. AT&T,
for example, is expected to produce $8 billion to $10 billion of free cash flow
that could be applied to debt reduction, analysts say. It is also common for
telecom companies to carry high debt because they invest heavily in their
networks and their customers provide them with reliable revenue.
AT&T’s and Comcast’s other motives for borrowing are
fairly typical. Both companies are grappling with slowing growth and increased
competition caused by technological change, and they rely heavily on stock
dividends and repurchases to satisfy shareholders. Comcast’s offer for Fox at
$35 per share puts it in a bidding war withWalt
Disney Co. DIS -1.64% ,
which is bidding $29.54 per share to buy Fox.
Many corporations facing similar headwinds responded by
raising debt in recent years, an easy choice given low borrowing rates created
by ultraloose central bank policies across the globe.
Still, the scale of debt AT&T and Comcast would carry
if both purchases succeed is unprecedented, and debt investors are scrambling
to analyze the consequences.
“We are getting a lot of calls,” says Allyn Arden a telecom
and cable analyst at S&P Global Ratings. S&P and Moody’s cut their
ratings on AT&T bonds Friday to a level two notches above the junk-debt
category.
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The cut, and an anticipated downgrade of Comcast, are
expected to lower the average ratings of most investment-grade corporate bond
portfolios because AT&T and Comcast are such large components of the
benchmark indexes tracked by investment firms. Should AT&T complete its
acquisition of Time Warner, it would comprise at least 1.93% of the widely
followed Bloomberg Barclays U.S. IG corporate bond index compared with about
1.59% currently. A combination of Comcast and Fox would make up at least 1.38%
of the index, up from Comcast’s current 1.04% quotient.
If the two companies repay debt used for the acquisitions
as planned, they could quickly return to their pre-deal credit ratings.
Conversely, if the forecast benefits of the mergers don’t materialize or if technological
disruptions shrink revenues, ratings firms could make further downgrades.
AT&T will have about $181 billion of debt because of
the Time Warner purchase but other liabilities, including operating leases and
postretirement obligations, amount to about $50 billion, Mr. Arden says. As a
result, S&P estimates the company’s post-deal leverage at about 3.5 times
earnings before interest, taxes, depreciation and amortization, or Ebitda. That
is slightly below the 3.75 times leverage that S&P views as typical for
comparable telecommunications companies rated triple-B-minus, the lowest
investment grade rating.
AT&T calculates its leverage at 2.9 times Ebitda, but
doesn’t include leases or postretirement obligations in the figure. The
telecommunications firm forecasts returning to 2.5 times within four years, a
person familiar with the company said.
Should additional rating cuts put the company on the edge
of junk-debt category, fund managers who are prohibited from holding debt rated
below investment grade might start to sell its bonds pre-emptively.
“The risk is that everyone wants to get out of the debt at
the same time,” Mr. Collins said. “That’s when it gets ugly.” When oil prices
plummeted in 2015, for example, the debt of some energy pipeline companies with
low investment-grade credit ratings fell 15% in a matter of months.
Gene Tannuzzo, portfolio manager of a $4.3 billion debt
fund for Columbia Threadneedle Investments, has halved his exposure to bonds of
telecommunications and media companies over the past year because of their
rising debt and headwinds facing the industries. He has sold out of Comcast
bonds entirely but would consider purchasing debt backing the Fox purchase if
it paid a high enough yield, he said.
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