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Credit Woes Whack Tech M&A

Daniel Del'Re

SAN FRANCISCO -- The bloodletting in the credit markets may soon start to spill into the tech sector.

The widening credit crisis is exposing the vulnerability of tech companies that have borrowed avidly in recent years as hedge funds, pension funds and other large investors have loaded their portfolios with corporate debt, holding down interest rates.

The tighter link to the credit markets could choke the growth of tech companies that have made acquisitions a major plank of their expansion plans. In recent years, IT services firms as well as makers of software, semiconductors and telecom gear have used cash instead of stock to make acquisitions.

The reliance on debt is showing up on their balance sheets at a time when skittish investors are draining the credit markets of liquidity, making it costlier to refinance existing debt or take on new debt.

Software maker Oracle (ORCL), for instance, spent nearly $20 billion in cash on acquisitions over the last three years.

In that time, the company's debt as a proportion of total capital, a common measure of a company's debt burden, rose from 2% to 31% according to a study by the Center for Financial Research and Analysis.

One of the companies with the most pronounced balance sheet effect is Affiliated Computer Services (ACS), which has used over $1 billion in cash to make acquisitions over the past three years.

During that period, the company's ratio of long-term debt to total capital jumped from 5% to 54%, according to the study by the Center for Financial Research and Analysis.

In a recent conference call, ACS' management expressed confidence in its ability to use acquisitions for growth. But credit rating agencies Moody's and Standard & Poor's have already downgraded ACS' creditworthiness because of its heavy borrowing.

This could force the company into spending cash on its balance sheet rather than relying on pliant debt markets.

Smaller tech companies have also joined the fray to borrow money for acquisitions.

Macrovision (MVSN), for one, which makes copyright protection software, used debt to help finance $195 million in acquisitions over the past three years. Its ratio of debt to total capital has risen to 34% from nearly zero over that period of time.

Companies with heavy debt loads may face burdensome interest payments if they have to issue new bonds to replace those coming to term.

"If companies have debt that is maturing, the issue is whether they have enough cash on their balance sheet to retire the debt, and if not, are they going to be able to refinance it in the current market environment," says Robert Stimpson, a growth investor and manager of Oak Associates' River Oak Discovery Fund and Rock Oak Core Growth Fund.

Credit market turmoil has widened the spread between the yields on Treasury bonds and some corporate debt by roughly two percentage points, according to data from UBS.

This difference in yields can be especially painful for companies like the semiconductor maker Rambus (RMBS) that may be in technical default on debt because they haven't filed financial statements with the Securities and Exchange Commission on time.

Bond holders have called on Rambus to repay $160 million in bonds ahead of schedule. They argue that Rambus triggered early repayment clauses by delaying quarterly filings because of an ongoing probe into how stock option grants were dated.

Likewise, ACS is locked in a legal standoff with creditors seeking early repayment on bonds because of the company's failure to file its 2006 annual report.

Other late filers include computer maker Dell (DELL), software maker BEA Systems (BEAS) and the IT-services giant Computer Sciences (CSC).

Provided that credit market conditions don't deteriorate further, Stimpson doesn't foresee the tech sector imploding like the financial services, real estate and homebuilding industries have.

Call for early repayment of bonds should be limited to a subset of tech companies that have taken advantage of cheap credit and found themselves embroiled in the options backdating scandal.

"Many tech firms have been at peak profitability for several years and have high cash balances," which makes them better credit risks and keeps a lid on the interest they pay, says Stimpson.