The Daily Interview: Do Tech Companies Have Too Much Debt?
Not long ago, when the capital markets were booming, most stockholders didn't pay too much attention to company debt loads. But now that credit has tightened and companies must contend with falling revenues, skimpy balance sheets are a cause for concern. (For more on this issue, see this recent TSC story.)
Managing Director of Corporate Ratings
Standard & Poor
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TSC: First of all, can you explain what kinds of factors bond analysts look at when they're evaluating a company? How is it different from what equity analysts would consider?
Wetreich: Well, a lot of it is very similar in the sense that we're focused on competitive position and the fundamentals in the sector, and we use that analysis to risk adjust the company's financial risk. The riskier the business is, the greater the financial cushion a company would have to have for a given rating. So if a company has a very stable and predictable cash flow, like AOL Time Warner (AOL), they might not have to have as strong financial ratios for the same rating as a company in very cyclical business would.The financial ratios we look at are things like total debt to EBITDA [earnings before interest, taxes, depreciation and amortization] or EBITDA interest coverage. TSC: If you were to consider two rival companies, how much of an advantage would it be if one of them didn't have any debt? Wetreich: Clearly, not having financial pressure in terms of maturities, funding requirements and not having liquidity issues is certainly a big positive. That is one of the reasons why many tech companies keep large cash positions. Because when things go bad they can burn through quite a bit of cash in a short time, and they still have to invest in R&D, so they're in a position to benefit when the cycle turns around again. TSC: What does it mean when a company is put on a credit-watch list, as Nortel (NT) was recently? [Note: Standard & Poor's has not downgraded the company, but Moody's issued a downgrade earlier this week.] Does it become more expensive to obtain debt at that point, even before a downgrade? Wetreich: A credit watch merely means there's a formal review going on. In the case of Nortel, we've indicated a range of final outcomes, but when the final review is completely done, we expect it to remain investment grade. I think their cost of capital, given their current situation, has probably increased from what it was. TSC: How much worse is a downgrade than being watchlisted? What does a downgrade mean for a company like Lucent (LU), whose debt recently got downgraded from investment-grade to junk-bond status? Wetreich: The lower the rating, typically the higher the cost of capital would be. For most companies, a rating downgrade would typically imply a higher borrowing cost for that company. And there are certain funds that can only hold investment-grade paper. They have to sell the bonds when it gets downgraded out of investment-grade. TSC: Given that tech companies have seen a pretty sharp business downturn recently, are they considered risky from a debt standpoint? How much of a concern are debt levels in the sector? Wetreich: If I could make an overall comment, the tech sector probably has a higher than average business risk relative to the overall industrial sector, but many companies offset this by adopting fairly conservative financial risk profiles. They often have little debt and substantial cash positions [compared to] more traditional companies. There's a very broad range of business risk within the tech group. There are a lot of startups, but also very established service companies like EDS (EDS) and Computer Sciences (CSC), strong software companies like Oracle (ORCL) and Computer Associates (CA), and those companies are not feeling the pressure to nearly the extent that maybe some of the hardware and telecom equipment companies are. Despite the gloom and doom in the tech sector, the ratings distribution and the outlook distribution [i.e, the bias toward raising or lowering ratings] is very similar to that of industrials overall. So you'd think this is a very depressed sector, but the ratings and outlooks are very similar to industrials. And the upgrade-to-downgrade ratio in the tech sector is better than it is for industrials. For the first six months, there's been a ratio of over four-to-one of [ratings] downgrades to upgrades for industrials, compared to a two-to-one ratio of downgrades to upgrades for the tech sector. It's still a negative trend, but not as bad as for industrials overall. One might think it would be worse given the [bad] press and earnings coming out of the tech sector.
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