Corporate finance: The high cost of cheap money

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By:
Louise Bowman
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When companies are allowed to borrow aggressively at ultra-cheap rates, things can turn ugly fast when trouble strikes.

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Debt-fuelled acquisitions can be hard to resist when there seems little prospect in sight of interest rates returning to anything approaching normal levels.

Claims that the 30-year bull run in the bond market ended in January when 10-year US Treasury yields shot up to 2.6% ­­– a high not since for, oh, nine months – sound like the usual attention-seekers crying wolf.

There is no realistic prospect of rate rises in Europe any time soon.

It is perhaps surprising that the net result of this – artificially cheap debt – hasn’t wreaked more corporate havoc yet. However, turning amending and extending loans into extending and pretending that repayment is ever likely to happen will have consequences down the line.

New research published by Ryan Banerjee and Boris Hofmann at the Bank for International Settlements recently looked at zombie companies, which it defines as firms that are at least 10 years old, whose ebitda does not cover interest payments and which have low future growth potential.

Their research examined nearly 32,000 publicly quoted companies in 14 OECD countries since 1980. They reach the not entirely surprising conclusion that zombies are now more prevalent – after 10 years of monetary easing and ultra-low interest rates.

In 1987, the probability of a zombie firm remaining a zombie in the following year was 40%; by 2016 it had risen to 65%, according to their findings. This is what happens when investors chase assets and are willing to refinance almost anything at any price.

Debt-fuelled

The recent travails at two highly acquisitive, debt-fuelled conglomerates have shown, however, that cheap debt can come at a high price for any corporate and its owners.

South African retailer Steinhoff International provided a spectacular case study in value destruction at the end of last year when its share price fell 62% in one day. This followed the announcement on December 5 that the firm would postpone its FY2017 results announcement while PwC performed an independent investigation into accounting irregularities. CEO Markus Jooste resigned immediately.

Suggestions of accounting irregularities at the sprawling conglomerate first came to light in a German business news magazine in August, but on December 6 Steinhoff’s board confirmed that this could impact the valuation and recoverability of up to €6 billion-worth of non-South African assets.

German prosecutors are investigating inflated revenue figures at certain subsidiaries. These irregularities seem to involve the alleged funding of off-balance sheet purchases of loss-making Steinhoff subsidiaries, although until PwC completes its work the exact nature of the problem is unclear.

There has, however, been concern around the name for some time: according to Markit, 40% of Steinhoff shares that were available to borrow were out on loan before the December 6 announcement – showing how many people were already shorting the stock.

Whether or not fraud has taken place, the situation at Steinhoff is not helped by its complex and opaque corporate structure. It is also aggravated by the debt associated with a string of recent acquisitions that the firm has made.

In September 2016, the firm announced it was buying Houston-based Mattress Firm for $3.8 billion – a target that had itself made 18 acquisitions since 2007 resulting in a seven-fold increase in its outstanding debt in four years to $1.3 billion.

The £610 million acquisition of UK-based discount retailer Poundland at the same time added up to a $5.5 billion bill for a firm that had already spent the last decade on a debt-fuelled acquisition spree that had paid high multiples for struggling discount retailers and seen nine companies acquired in just two years.

Steinhoff has €10.7 billion debt outstanding – almost all of it unsecured – which includes a €2.5 billion term loan due in March. Its market cap is now around €2 billion. This precipitous fall from grace has even ensnared the European Central Bank, which could have lost around €50 million from its investment in Steinhoff International’s €800 million 1.875% bond due in 2025 that was issued in June 2017.

The central bank revealed it had sold its entire Steinhoff holding in early January.

Revenue warning

Another firm that has seen debt-fuelled acquisitions start to weigh heavily on its share price is telecoms group Altice. Its shares fell 7% on Wednesday after news of a revenue warning for its French business SFR. Altice shares cratered towards the end of last year and have now halved in price over the past three months.

The company has now amassed €51 billion in debt and has announced a restructuring that will see the spin-off of Altice USA to help reduce leverage in Europe. This will, however, increase leverage in its US business Cablevision to more than six times.

The situations at the two firms are very different, but as news of their problems washed through the market at the start of the year it seemed a timely reminder that ultra-cheap debt usually fuels a flurry of corporate activity that does not end well.

On January 4, Steinhoff announced that despite meeting with its lenders, “significant near-term liquidity is still required”.

So many firms have taken such liquidity for granted for so long that the market might end up footing the bill for many years to come.