At a time when the IMF estimates that more than 20% of the world’s companies would be unable to cover their interest payments if interest rates moved sharply higher, Comcast and AT&T are poised to become the most indebted companies in the world following media megadeals that leave the two companies with little room to maneuver if profits fail to materialize, according to the Wall Street Journal.
As WSJ points out, assuming both are finalized, the deals would leave the two companies with a combined $350 billion in bonds and loans, more than one-third of a trillion dollars in debt. The number is making some bond fund managers nervous, and some are saying they won’t include Comcast or AT&T debt in their portfolios – unless they bear a suitably high yield.
“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.”
But rather than looking at these deals as isolated examples, WSJ reminds us that companies only arrived at this level of corporate indebtedness following a decadelong surge in corporate borrowing, as companies – including these two telecoms giants – eagerly bought back their shares to appease investors, and financed these purchases with debt. Global corporate debt, excluding financial institutions, now stands at $11 trillion. Meanwhile, the median leverage for companies with an investment grade rating has increased by 30% since the financial crisis.
AT&T’s now-closed deal to buy Time Warner has left it with nearly $200 billion in debt, a leverage ratio that is just below the average for companies rated at the bottom of the investment-grade ladder (though to be sure, the company says it’s leverage is significantly lower).
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.
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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.
The company has sought to reassure bond-fund managers by promising to a leverage ratio of 2.5 (by the company’s calculation) within four years. But if ratings agencies do the unthinkable and stick Comcast and AT&T with (well-deserved) junk ratings, fund managers who are prohibited from holding below-investment-grade debt will be forced to preemptively dump the bonds. This worry has caused some fund managers to bail out of media and telecoms corporate debt entirely, thanks to the companies’ typically high debt levels.
“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.
S&P and Moody’s – the two most important ratings agencies – cut their rating on AT&T’s bonds on Friday to two notches above junk. And a cut and possible downgrade for Comcast would be expected if it closes a deal with 21st Century Fox (a deal that is also being pursued by Disney).
Meanwhile, projections released by the Fed after it announced its decision to raise the Fed funds rate last week showed that FOMC members raised their dots, resulting in an increase in the median expectation from one to two more hikes this year (likely in September and December).
And with the economic expansion now the second-longest in history, now certainly sounds like a sensible time to take on an unheard of debt burden.
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