How major corporations got into a $ 2.5 trillion debt hole on the eve of a pandemic

US, WASHINGTON (ORDO NEWS) — Over the years of economic growth, which broke off with the onset of the coronavirus pandemic, leading US corporations in an effort to please shareholders have accumulated trillions of dollars of debt. Now they can only hope for the help of the state.

When CEO Doug Parker stepped up at the helm of American Airlines in December 2013, the future of the airline seemed bright. Until that moment, the manager led US Airways, which, having agreed to merge with the bankrupt American Airlines, became the leader in the US passenger air transportation market. A new company, almost unencumbered by debt, appeared in the country, in which only three competitors with the same scale of business remained in the domestic market.

Steep peak

The financial crisis was far behind, the economy was gaining momentum, and for passenger traffic, it seemed, a new golden age was approaching. By that time, companies like American Airlines had perfectly mastered the science of dynamic pricing: almost every seat in the cabin was occupied on each flight, making the business as profitable and profitable as possible. Looking forward to the era of “new American Airlines” by early 2014, Parker sought to cater to Wall Street financiers. During one call with investors, he even said: “I assure you: everything we do is aimed at maximizing profit for our shareholders.”

Over the next six years, Parker was actively attracting borrowed funds. The company approached the capital market at least 18 times and thus received a loan of $ 25 billion. The general director spent money on the purchase of new aircraft, as well as, for example, on fulfilling pension obligations. A number of passenger fees – for extra baggage, more legroom, snacks, drinks on board and much more – helped the carrier earn $ 17.5 billion in total profit from 2014 to 2019. Keeping his word in 2014 Parker announced the first dividend payment in 34 years and launched a share buyback program.

Until recently, business was booming, and today American Airlines’s financials are worse than ever.

Then he reasoned: “Keeping more funds than the company needs is not the best use of the capital of our shareholders.” For hedge funds buying American Airlines securities, such words were like balm for the soul. Even Warren Buffett acquired a stake in the company. The stock price of a recent bankrupt instantly soared, and in just the first year, under the leadership of Parker, the value of securities doubled. For his success, the CEO received an annual bonus of more than $ 10 million.

But fast forward to April 2020: the coronavirus destroyed the tourism industry, and American Airlines remained penniless during the crisis, partly due to Parker’s waste. The US government agreed to give the company $ 5.8 billion in grants and loans at low interest rates. This is the largest targeted payment under government support for the industry, for which $ 25 billion was allocated. Many hedge funds, as well as Berkshire Hathaway, sold their shares to American Airlines. Now the company’s capitalization is only a third of the $ 12 billion that Parker spent on just one share repurchase.

And although until recently, business was booming, today the financial performance of American Airlines is nowhere worse. For six years, Parker has increased net debt by more than $ 7 billion, and now its ratio with revenue is 45%, which is double the mark of the end of 2014. The company says it intends to “aggressively” repay its debts as soon as the business returns to normal.

Save corporations

However, American Airlines, which is mired in debt, is not very different from other American corporations. We can say that Parker’s manipulations with finances have become a guide to action for many companies. From year to year, as the Federal Reserve System (FRS) poured liquidity into the economy, major players such as Coca-Cola, McDonald’s, AT&T, IBM, General Motors, Merck, FedEx, 3M and Exxon have been attracted every now and then. borrowed funds at low interest rates.

Many took more money than was necessary for operating activities, often returning them to shareholders by repurchasing securities and in the form of dividends. In addition, borrowers actively bought other companies. All this led to a record increase in the S&P 500 index, an average of 13.5% each year from 2010 to 2019. Along with this, generous payments to the general directors of the parade also increased. A control shot was fired by Donald Trump in 2017 when he signed the law on tax reform, due to which corporate debts grew even more.

A year ago, the Fed chairman sounded the alarm, but due to growth in the stock markets, no one heard him.

Only a few were able to resist light loans. After analyzing the performance of 455 companies from the S&P 500 index (with the exception of technology giants with a significant share of cash such as Apple, Amazon, Google and Microsoft), Forbes came to the conclusion that on average over the past decade, these companies have increased their net debt almost threefold, receiving “ on hand “about $ 2.5 trillion of borrowed funds. For each new dollar of revenue in the reporting period, almost a dollar of debt fell, it follows from calculations: from an average of 20 cents per dollar of revenue at the beginning of the decade, the debt indicator today rose to 38 cents.

But since the pandemic inflicts a crushing blow on world trade, American corporations have to put up with disappointing reality: their income has evaporated, but huge debts have not gone away.

A year ago, Fed Chairman Jerome Powell sounded the alarm, but due to the rapid growth in the stock markets, almost no one heard him. “The problem is not only that the amount of debt is large,” Powell explained in May 2019, “but also that growth is observed in those forms that are associated with much greater risks <…> The vast majority of investment-grade bonds has the lowest rating possible. This is also called the “cliff of BBB investments.” Powell said that the debt securities of a huge number of companies were at risk of collapsing into “junk” status. He warned that “investors, financial institutions and regulators should take this risk into account especially today, before the situation worsens.”

However, since then Powell has not made any alarmist statements. On March 23, against the background of the terrifying prospect of total insolvency of locomotives of the American economy, the Fed announced the creation of a specialized lending agency that will support the functioning of the corporate bond market. Two weeks later, the regulator stunned Wall Street with a statement that it intended to enter the open market and acquire “junk” bonds, as well as shares of high-yield exchange-traded investment funds.

As a result, in order to help large companies survive the pandemic, the Fed allocates $ 750 billion, including $ 75 billion from taxpayers, all within the framework of the $ 2.3 trillion state anti-crisis support package.

Generous McDonald’s

Billionaire Howard Marks, co-founder of Oaktree Capital’s asset manager, said in a memo on April 14: “At the last frontier, we have a buyer and a creditor who is trying to soften the blow and at the same time takes on the role of the free market. When people understand that the government will protect everyone from the unpleasant consequences of their own actions, we are dealing with a “dishonesty risk”. People and companies, of course, are protected from damage, but nobody learns from such mistakes. ”

The lesson for borrowers with great appetites is very clear: taxpayers are not a priority, and the state support crane is open to the full. According to the consulting agency Refinitiv, in just the last two months, at least 392 companies issued bonds and other securities worth $ 617 billion (including a record number of those very shares with a BBB rating), gaining even more borrowed funds, which they are unlikely to will be able to return. As Warren Buffett noted at the annual meeting of shareholders on May 2, “everyone who issued bonds at the end of March and April should send a letter of appreciation to the Fed.”

Some socially responsible American companies, largely responsible for accumulations in the country’s pension system, fell into the credit trap not on their own initiative – not the least role in this was played by cunning Wall Street businessmen. Take at least McDonald’s. For a cult network of fast food restaurants, it all began before the crisis of 2008, when billionaire investor Bill Ackman began to drive management to transfer establishments (there were about 9,000 then) to independent operators and launch a share buyback program with the proceeds $ 12.6 billion worth

As Warren Buffett noted, “everyone who issued bonds at the end of March and April should send a letter of appreciation to the Fed.”

Initially, the “predatory” proposal was rejected, but several years later, when the network growth after the crisis slowed down, McDonald’s management returned to the idea. In 2014, Don Thompson, the CEO of the network, began to borrow money for the repurchase of shares. A year later, his successor Steve Easterbrook gave the predecessor’s strategy an additional incentive by launching a large-scale franchise program, as Ekman had previously advised. Today, 93% of the nearly 39,000 chain restaurants worldwide are run by small entrepreneurs: they incur maintenance and rental costs, as well as license fees for managing McDonald’s establishments, using equipment, and selling products.

The updated and improved McDonald’s “without extra assets” no longer manages onerous property, but receives payments and sits with tens of billions of debt. From the end of 2014 to the end of 2019, the network issued debt securities worth about $ 21 billion. Also, shares of more than $ 35 billion were bought and dividends of $ 19 billion were paid, that is, more than $ 50 billion was returned to shareholders, despite the fact that the company’s profit for that period amounted to only $ 31 billion.

On Wall Street, this was fine with everyone. The network has become the darling of hedge funds, and over the period from 2015 to 2019, under the leadership of Easterbrook, its stock price has more than doubled. In total, over five years, the leader received a generous bonus of $ 78 million.

However, the risks to McDonald’s financial performance turned out to be huge. In 2010, the company’s debt amounted to only 38 cents for every dollar of annual revenue, and by the time of Easterbrook’s dismissal amid an office romance at the end of 2019, it was $ 1.58.

Today, the corporation’s net debt is at $ 33 billion, which is almost five times more than before the financial crisis. McDonald’s bonds have a rating of BBB, that is, slightly higher than the “junk” status, although in 2015 they belonged to class A.

With the onset of the pandemic, most McDonald’s restaurants became empty, and initially the company’s quotes fell by almost 40%. However, after the intervention of the Federal Reserve System, the debt of the corporation, which initially decreased to 78 cents per dollar of revenue, returned to its previous values ​​along with the stock price, when the network quickly raised an additional $ 3.5 billion. McDonald’s insists that the company entered into a crisis with excellent performance and in good financial condition. She recently suspended the repurchase of her shares.

Historic bubble

The frightening truth is that McDonald’s debt is quite modest when compared to competitors from Yum! Brands, companies with annual revenues of $ 5.6 billion and the owner of brands such as Pizza Hut, Taco Bell and KFC. After the post of CEO of Yum! in 2015, Greg Creed took over, hedge fund managers – Keith Meister from Corvex Management and Daniel Lobe from Third Point gained a great influence on the business. By October of that year, Meister even got a seat on the board of directors of Yum! A few days after his appointment, the company announced that it “intends to return a substantial part of the capital to its shareholders” and makes the Chinese division of Yum China, which then brought 39% of all profits, an independent enterprise.

Over the next year, Creed borrowed $ 5.2 billion for a $ 7.2 billion share buyback and dividend program. Yum! about 31% of ordinary shares were abolished, and by the end of 2019, the stock price doubled to a mark above $ 100 apiece. Shareholders were thrilled, but the stability of the business shook dramatically. In 2014, the holding’s net debt amounted to only $ 2.8 billion, or 42% of revenue, and by 2020 it soared to $ 10 billion, or 178% of revenue. A pandemic could have turned into a disaster for irresponsible management, but the Fed has set its shoulder. Another bond issue in April of $ 600 million helped. Yum! will live more than one day.

“A debt bubble of historical proportions has grown. But while the feeder worked as it should, no one objected ”

At the same time, the company’s management rejects the thesis that the government helped in some way: “We don’t know anything about any Fed intervention in the market or about the facilitation of our issuance of bonds for $ 600 million by the regulator.”

Like McDonald’s, Yum! sold many of its own points to independent franchisees. Without access to capital markets and the generosity of the authorities, the future of the corporation remains vague. For some franchisees, the holding provided a 60-day delay for paying royalties. In early April, David Gibbs, who replaced Creed in the CEO’s chair in January, suggested that if necessary, the company would be able to pick up establishments for itself and subsequently resell it.

Of course, some believe that the actual repurchase of public companies for credit funds, as is the case with McDonald’s and Yum !, is justified, especially if we take into account the “cheap” money policy that the Fed has been pursuing for ten years. Dan Zvirn, head of asset management at Arena Investors, notes: “With regard to corporate capital, it was very irresponsible to resort to excessive financing through securities, especially given the incredible cheapness of loans.”

According to the Federal Reserve Bank of St. Louis, as of the end of 2019, the total debt of non-financial enterprises amounted to $ 10 trillion, that is, since the beginning of the decade it has grown by 64%. “Each cent of cash injections from the Fed turned out to be the same amount of corporate debt that went into the repurchase of shares. And this ultimately triggered a fall in the S&P 500 index to its lowest level over the past two decades, ”explains economist David Rosenberg. “So a debt bubble of historical proportions grew <…> On the other hand, while the feeder worked as it should, no one objected.”

Too big to fall

If there was any reward for carelessness in managing the company, few would surpass the mighty Boeing, the world’s largest manufacturer of equipment for the aerospace and defense industries, as well as the largest exporter in the United States. A past pride in engineering throughout America, Boeing has been too keen on sophisticated financial instruments in recent years.

In 2013, the Chicago concern decided that it would be reasonable to give almost all the profit to the shareholders. The company allocated $ 64 billion for the plan: $ 43 billion for the repurchase of shares and $ 21 billion for dividend payments. At the same time, Director General Dennis Malenberg has very few resources left to mitigate potential problems, such as disruptions in production, labor conflicts and a decline in business activity.

A business that had virtually no debts back in 2016 completed 2019 with $ 18 billion in debt.

For five months at the turn of 2018-2019, two Boeing 737 MAX aircraft crashed, and in 2019 the US Federal Aviation Administration suspended the operation of the entire fleet of the new model. After that, the aggressive financial policy of the company became apparent: now, for emergency financing, it was forced to resort to lending. So the business, which back in 2016 had virtually no debts, completed the 2019th with $ 18 billion of net debt. In March 2020, Boeing completely exhausted its credit limit of $ 13.8 billion to deal with the consequences of the “pandemic” crisis, and S&P downgraded the group’s credit rating to the lowest level in the investment class.

At first, the company seriously thought about direct assistance from the state and even asked the government to allocate $ 60 billion to support the industry. But in late April, CFO Greg Smith told investors that the US Department of Defense was taking measures to increase Boeing liquidity and that the Social Assistance Act The support and economic security of those affected by the coronavirus helped defer the payment of certain taxes. In addition, the company began to consider financing options for programs of the US Treasury and the Fed.

On April 29, Boeing’s new CEO David Calhoun said: “We believe that government support will be critical to ensuring access to liquidity for our industry.” And the very next day, the concern issued $ 25 billion worth of bonds to the stock market and thereby negated the need for direct financial assistance. Demand exceeded supply: investors had no doubt that the restoration of Boeing was a matter of national importance for the government.

$ 6 billion for a competitor

While Boeing was struggling to return funds to shareholders, Randall Stevenson, the undisputed CEO of telecom giant AT&T for 13 years, dreamed of becoming a entertainment giant through corporate takeovers. Since the manager headed the corporation with a 143-year history, he has spent over $ 200 billion – mainly for the acquisition of other companies, in particular DirecTV and Time Warner, as well as for the repurchase of shares and dividends in the amount of $ 2 from each paper. At the same time, under the leadership of Stevenson, the company’s debt grew by $ 100 billion.

Telecommunications analyst Craig Moffett notes: “AT&T is the world’s largest debtor among non-financial organizations.” The corporation accounts for a significant part of that total corporate debt of more than $ 10 trillion – and who, if not the state, will save a giant of this scale from collapse? Fed Chairman Jerome Powell, in a recent interview with the 60 Minutes show on CBS, commenting on the prospects for a debt collapse, said: “We are ready for anything, even in the long term.”

In a letter, the hedge fund stated that “AT&T provided the main competitor with capital for years to come”

Elliott Management’s hedge fund, which owns a stake in AT&T, openly criticized Stevenson’s quirks in a letter to the board in September 2019: “AT&T acquired DirecTV satellite provider for $ 67 billion at the absolute peak of the linear television market. And the purchase of Time Warner for $ 109 billion [management] has yet to give a clear strategic rationale.”

However, the Stevenson team’s worst venture, a fund known for criticizing corporations, said it’s attempted takeover of T-Mobile for $ 39 billion in 2011. The same letter said: “The potentially most destructive deal was never completed.” Then it turned out that corporate funds were wasted for a year – as a result, AT&T decided to withdraw from the agreement. For this, the holding company had to pay T-Mobile a record $ 6 billion compensation. In a letter to Elliott Management, it was stated that “AT&T provided the main competitor with capital for years to come.”

According to both the hedge fund and other investors, AT&T simply robbed its shareholders. Unlike Boeing, where the craving for loans and the repurchase of shares led to the growth of quotations, AT&T securities went into the peak for a decade. The only common feature for this couple of “insatiable” corporations is that, at least from a financial point of view, they have long since lost the image of “blue chips” that they were in the good old days.

Parade of irresponsible

The coronavirus pandemic has become a “black swan” for the global economy, but for American corporations, the end of the era of credit binge associated with it may still be flowers. Companies that fall into the debt hole due to short-sighted management cannot see the edge, and in the event of a prolonged recession, many of them may become completely insolvent, especially if interest rates rise, and then inflation, all thanks to the Fed’s multi-trillion-dollar “bailout” plan economics at all costs.”

Over a decade, O’Reilly’s debt grew 12 times to $ 4 billion. On March 25, just in case, the company borrowed another $ 500 million.

Over the past ten years, Altria Corporation, the Marlboro cigarette manufacturer, has increased debt from $ 10 billion to $ 26 billion. Most of the profits were spent on dividends and share buybacks, and another $ 15 billion spent on stakes in the young leaders of the electronic cigarette market and the legal market. Cannabis – Juul Labs and Cronos Group. However, both promising “chips” were unprofitable. Compared to 2010, when the tobacco giant’s net debt ratio was 58 cents per dollar of revenue, the figure today is $ 1.31.

For most of its 118-year history, 3M from Minnesota, which produces famous masks such as the N95, as well as stickers for notes and scotch tape, had almost no debt. And from 2010 to today, its debt has grown 17 times – almost to $ 18 billion, or 55% of annual revenue. In February, S&P downgraded the 3M bond rating, and the company became one of the first players to issue additional bonds when resuming trading in late March.

Missouri’s O’Reilly Automotive chain of auto parts stores, which generated around $ 10 billion last year, has been very popular on the stock exchange over the past ten years. The family-owned company discovered cheap loans in the 2010s and took them into service – for the repurchase of securities worth $ 12 billion and the abolition of almost half of the shares in circulation. Over a decade, O’Reilly’s debt grew 12 times to $ 4 billion. On March 25, just in case, the company borrowed another $ 500 million.

General Dynamics, the manufacturer of ships for the US Navy and Gulfstream jets, also had almost no debts in 2010. But since Phoebe Novakovich became CEO in 2013, the company bought back its own shares for $ 13 billion and paid dividends for $ 6 billion. Because of this, General Dynamics ended 2019 with a net debt of $ 11 billion.

For many years, IBM was the leader in the field of share buybacks: from 2010 to 2019, it returned to shareholders 90% of its own cash flow, or $ 125 billion. Debt at the same time increased from 17% of annual revenue to 70% and now is $ 52 billion

Oracle miss

On the craving for light loans, even Berkshire Hathaway was caught. In 2013, Warren Buffett joined forces with the Brazilian private investment firm 3G Capital, one of the founders of which is billionaire Georges Paulo Lemann. In partnership, they acquired food producer Heinz for $ 28 billion, and two years later, Kraft Foods for $ 47 billion. The new merged company had many brands with a rich history, such as Jell-O desserts, Velveeta cheese products and Oscar Mayer processed foods, and a lot of debts of $ 30 billion. After an unsuccessful attempt to acquire Unilever for $ 143 billion, which would require $ 90 billion of additional borrowed funds, the situation in the food holding began to deteriorate.

In a sense, the actions of the Fed are equivalent to trying to cure a drug addict by increasing the dosage

Kraft Heinz’s market capitalization fell from a peak of $ 118 billion in February 2017 to $ 38 billion. Berkshire’s share, estimated at the time of purchase of $ 13.8 billion, now stands at only $ 10 billion. In February, S&P and Fitch downgraded Kraft Heinz securities to the trash. The company itself still maintains that financial performance, as well as demand for the products of its brands, are on top.

Even the patriarch of the American investment market, Warren Buffett, could not resist the temptations of earning money by inflating the debt bubble: his Berkshire Hathaway was burned on the super project Kraft Heinz

Meanwhile, many in the US oil industry are so bad that they simply cannot afford the generous support from the Fed. Vicky Hollub, CEO of Occidental Petroleum, has stepped up the company’s debt almost five times since taking office in 2016 to $ 36 billion. Last August, a deal worth $ 55 billion was closed on its acquisition of Anadarko Petroleum. The merger took place shortly before Russia and Saudi Arabia filled the market to the maximum with products at the beginning of 2020 and provoked the worst collapse in oil prices since the 1980s. At the time of publication of the article, WTI crude was trading at around $ 30 per barrel – in such circumstances, Occidental runs the risk of being restructured or even going bankrupt.

But if companies let go broke, this is likely to be the exception. The US government cannot allow the market to fully switch to self-regulatory mechanisms – the “sweeping” will be too much stress for the country. Only recently, Neiman Marcus, J.Crew and JCPenney have managed to declare bankruptcy.

The Fed clearly indicated that to prevent the expansion of this list and the rollback of the economy during the Great Depression, the regulator will consider corporations as essentially system-forming enterprises. Scott Minerd, director of investment at Guggenheim Partners, a consulting firm, believes that “the Fed and the Treasury have practically invented a new bad faith risk that makes it unlikely that a loan will be repaid.”

Financial analysts from BlackRock by the end of the year predict an increase in the Fed’s balance of “incredible” $ 7 trillion.

In a sense, the actions of the regulator are tantamount to trying to cure a drug addict by increasing the dosage.


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