Thanks For The Corporate Bond Bubble, Fed
by David Stockman, Contra Corner
Once upon a time businesses borrowed long term money—-if they borrowed at all—-in order to fund plant, equipment and other long-lived productive assets. That kind of debt was self-liquidating in the sense that it usually generated a stream of income and cash flow that was sufficient to service and repay the debt, and to kick some earned surplus into the pot as well.
Today American businesses are borrowing like never before—-but the only thing being liquidated is there own equity capital. That’s because trillions of debt is being issued to fund financial engineering maneuvers such as stock buybacks, M&A and LBOs, not the acquisition of productive assets that can actually fuel future output and productivity.
So it amounts to a great financial shuffle conducted entirely within the canyons of Wall Street. Financial engineering deals invariably shrink the float of outstanding stock among the companies visiting underwriters. Likewise, they invariably leave with the mid-section of their balance sheets bloated with fixed obligations, while the bottom tier of shareholder equity has been strip-mined and hollowed out.
At the same time, none of this vast flow of capital leaves a trace on the actual operations—-such as production, marketing and payrolls—of the businesses involved. Instead, prodigious sums of debt capital are being sold to yield-hungry bond managers and homegamers via mutual funds and then recycled back into windfall gains for stock market gamblers who chase momo plays and the stock price rips that usually accompany M&A, LBO or stock buyback announcements.
Needless to say, central bank financial repression is responsible for this destructive transformation of capital market function. It has made the after-tax cost of debt tantamount to free for big cap corporations——while fueling equity market bubbles that makes stock repurchases and other short-term financial engineering maneuvers irresistible to stock option obsessed inhabitants of the C-suites.
In this context, today’s WSJ saw fit to herald the $21 billion of quasi-junk bonds (BBB-) issued by Actavis PLC to fund its $66 billion acquisition of Allergen, a company which famously supplies Botox and similar life-enhancing products. Whether this mega-merger will result in any sustainable economic efficiency gains only time will tell, but the odds are not high. The overwhelming share of today’s red hot M&A deals fail to earn back the huge takeover premiums invariably paid. And, not infrequently, they are subsequently reborn as equally trumpeted corporate restructurings, spin-offs and other “value unlocking” maneuvers a few years down the road. It’s Wall Street’s version of “you stab ‘em and we slab ‘em”.
Yet there can be no doubt that funding the Allergen deal with $21 billion of freshly minted debt did accomplish the actual purpose of the financial engineering maneuver in question. Namely, it enabled Actavis to pay a bountiful premium to the selling shareholders without diluting its own shares.
And why not? The after-tax cost of the new debt will amount to a miniscule 2.4%. Consequently, the C-suite at Actavis acquired what amounts to a quasi-free option on the spread-sheet merger synergies and economies of scale postulated for the deal by Wall Street and its in-house financial engineers.
If these projected profits do not materialize or, as in the more usual case, if they are off-set with diseconomies of scale or operational and commercial dysfunction, the carry cost of the acquired assets will be negligible until they can be disposed in a “restructuring” event. No wonder CNBC celebrates Merger Monday and gets giddy when CEOs purportedly exhibit “confidence” in the future by launching new M&A deals.
Does this imply that the overwhelming share of M&A deals in this age of central bank financial repression amount to pointless financial engineering ploys designed to goose stock prices and stock option values, while substituting for genuine organic growth strategies? Yes it does. And the systematic resource misallocations and anti-growth consequences are profound.
Since yesterday’s Actavis deal was the second largest bond deal ever, it induced the WSJ to trot out the historical statistics. And they scream financial engineers at work.
As shown in the graphic below, the granddaddy of debt deals was last year’s $49 billion Verizon issue. This colossal obligation most definitely had nothing to do with the acquisition of plant, equipment and technology assets or even other people’s second hand assets.
Instead, it amounted to an internal LBO in which the parent company bought in the stock of its own subsidiary. That’s right—–a cool $49 billion of holding company debt was issued to change exactly nothing at Verizon except to shower public shareholders of a second tier subsidiary with a 50% windfall against their pre-deal trading price.
It goes without saying that no one except Wall Street analysts has lately mistaken Verizon for a value-producing enterprise. It is actually a serial deal machine—– a place where corporate value goes to die.
At the end of 2007, for example, it was already well down the slippery slope with tangible net worth at negative $10 billion. Today that figure stands at nearly negative $95 billion. Destruction of $85 billion of tangible equity value in just seven years is no mean feat——-even for a giant lumbering utility that has roughly 80 million quasi-captive customers to gouge.
There is no mystery to how Verizon navigated its way to the $100 billion negative (tangible) equity club. It borrowed itself silly funding “restructuring” charges and making vastly over-valued acquisitions. Thus, at the end of 2007 it had $31 billion of debt and today that metric stands at a staggering $113 billion.
What did Verizon get for the $82 billion in incremental debt that was on offer at bargain rates in the casino? It certainly wasn’t any explosion of current earnings; since 2007 its EPS has only inched forward at about 3.3% per year. And it wasn’t an old-style burst of investment capable of turbo-charging future profits. Its CapEx amounted to $140 billion over the last seven years, but 90% of that was needed to cover the DD&A charges on existing assets.
Viewed more broadly, Verizon and Actavis are at the top of the list, but they are merely super-sized versions of the generic syndrome. As shown below, the Fed’s massive money printing spree since the September 2008 crisis has fueled a massive increase in corporate debt issuance—–funds which have overwhelmingly been absorbed by non-productive financial engineering maneuvers.
The five largest debt deals of all-time shown in the graphic total $104 billion, for example, but every penny went to financial engineering and tax ploys. Sitting on $180 billion of cash, Apple most surely did haul coals to Newcastle with its $17 billion debt offering last year; and the other deals were more of the same debt financed M&A.
So far this year corporate bond issues total $241 billion. That’s a staggering $1.4 trillion annualized run rate—-or nearly double the run rate prior to the financial blow-off in 2008. Yet virtually all of this massive debt issuance has been cycled into after-burner fuel for the rocketing stock market. During the month of February alone, stock buybacks for the S&P 500 were a record $104 billion.
Is it any wonder that Wall Street threatens a hissy fit upon even a hint that the Fed’s rotten regime of ZIRP might be ended after 80 months? After all, it has amounted to free money for carry trade speculators and a cattle prod driving bond fund managers into corporate debt.