For America's weakest companies, today's credit markets are a miracle drug allowing them to cheat death.
Many firms with speculative-grade credit ratings are tapping a record high-yield bond market to repay existing debts. They also are refinancing their loans, pushing out maturities and nabbing lower interest rates. This "kick the can" approach has paid off for companies that investors left for dead just 18 months ago, including Rite Aid Corp., MGM Resorts International and auto supplier Tenneco Inc.
These companies' fundamentals still give cause for concern. MGM, for instance, recently posted a wider second-quarter loss of $883.5 million, compared with a $212.6 million loss a year earlier. Slowing MGM's progress: an inability to coax profits out of a new Las Vegas development.
Still, riskier debt is among the only ways to find higher yields as the Federal Reserve keeps interest rates near zero and yields on government bonds stay low.
Weaker companies are enjoying the spoils. "Junk-bond" deals this summer have yielded around 8.6%, according to Barclays Capital. That is lower than a year ago, when these yields were around 10%, and a far cry from the more than 20% that investors demanded during the financial panic in late 2008.
Only 5.5% of companies around the world with junk credit ratings have defaulted in the past year, according to Moody's Investors Service. As of November, 13.5% of these companies had defaulted during the previous 12 months.
But even as investors throw cash at these firms, a number of them could have trouble generating enough cash flow to service the debt in coming years, say analysts and restructuring advisers.
"For the 'maturity wall' to not be a problem and things to get better, you need real economic improvement, and that's not happening," said Kingman Penniman, head of credit research firm KDP Investment Advisors.
Some $800 billion in debt on risky companies' books matures over the next four years, according to Moody's. Lenders' decreased risk appetite, a double-dip recession or a prolonged period of mediocre economic growth all pose threats to the market's ability to absorb companies' refinancing needs, Moody's says.
"The interest rates don't seem to be following some of the fundamental risk profiles of the companies," said Kevin Cassidy, a Moody's senior credit officer.
About two-thirds of the new funds have been used to repay existing debt, rather than for deals or other capital expenditures. Companies rated B- or lower have issued $31.2 billion in debt so far this year, according to Diana Vazza, head of Standard & Poor's Global Fixed Income Research.
"When the dam breaks, it will be unbelievable," said Barry Ridings, the vice chairman of U.S. investment banking at Lazard Freres & Co. who advises companies restructuring their debts. Low-margin, consumer-dependent companies are "all going to be in trouble at some point if they have too much debt."
Many companies are getting new life both from junk-bond investors and banks. MGM, the big Las Vegas casino operator, nearly collapsed in 2009 amid more than $14 billion in debt and huge downturns in consumer spending and real-estate values. But MGM muddled through. In March, it extended maturities on more than $4 billion of a credit line to 2014 from 2011. It also sold $845 million in senior secured notes to repay some of that bank debt.
Moody's upgraded MGM's credit rating in March, but the casino operator remains in risky territory. It still has over $13 billion in long-term debt. "We believe that we have sufficient liquidity to address our upcoming debt maturities," said MGM's finance chief, Dan D'Arrigo.
The company's stock trades under $1 and maintains a weak credit rating that suggests it is at high risk for defaulting. The company didn't respond to requests for comment.
Risks aside, Investors are only too happy to do these deals, as they search for higher returns amid low yields on safer paper.
"All these companies don't have the cash flow to pay off all their debt, but they were never expected to," said Russ Morrison, a bank-loan fund manager at mutual fund Babson Capital. "They were expected to gradually pay it down and delever. Those things are just standard in this market."
Blockbuster Inc. shows how overconfident investors could be left holding the bag. Last fall, the movie-rental chain tapped the booming high-yield market to raise $675 million in new senior bonds. Investors enticed by the debt's 11.75% yield helped Blockbuster raise about twice the funds originally sought. The company used the money to eliminate its bank debt.
But Blockbuster continues to lose money amid intense competition from movie-kiosks operated by Coinstar Inc.'s Redbox and Netflix Inc., which mails DVDs and streams movies online. Today, its senior bonds have lost more than half of their value, and the company is warning it may have to file for Chapter 11 bankruptcy protection, or in the worst case, liquidate. Blockbuster declined to comment.
Other firms have defied the odds. In 2006, private-equity firms saddled hospital operator HCA Inc. with huge debt in a $31 billion leveraged buyout. In March, HCA pushed out the maturity on $2 billion of its bank debt to 2017 from 2013 and sold $1.4 billion in bonds to eliminate other bank obligations. Today, HCA is mulling a public offering of its shares.
Many companies, including Harrah's Entertainment Inc. and Unisys Corp., have avoided bankruptcy with distressed-debt exchanges. In these deals, companies often ask investors to retire current debt for new debt that matures later with sweetened terms, equity, or a combination of both. These deals can also feature debt buybacks.
Energy Future Holdings Corp., the former TXU acquired in a record $45 billion 2007 buyout by private-equity firms KKR and TPG Inc., recently said it would exchange $3.6 billion in notes for $2.18 billion of new notes and $500 million in cash. Despite that and other recent deals to chip away at debt, Fitch Ratings downgraded Energy Future two notches, noting it has $22 billion in debt due in 2014. Energy Future declined to comment.
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