No strings attached

louise purtle


The latest trend affecting bondholders is the amount of cash that is being thrown at stockholders. The utilities are leading the charge, followed closely by several telecom operators that are taking on decidedly utility-like characteristics. And many other cash-rich but growth-challenged companies are hearing a growing chorus of demands for higher dividends. Should bondholders sit silent on the sidelines as the din from equity investors grows?

After all, one doesn’t have to delve too far into the history books to find the last time that bondholder interests were trampled on as companies levered up to fund equity buybacks and maintain momentum in their stock prices.

The resultant ratings retribution saw virtually everyone take a quick trip to the confessional and then start pounding on the balance sheet bible in the pursuit of debt redemption, but it seems that lately attendance at the fiscal responsibility revival meetings is dropping.

Or is it? Balance sheets and credit metrics are in better shape now and the payment of dividends is one of the most benign weapons utilized in the battle between debt and equityholders. Management may not like cutting dividends given the signal this sends about a company’s state of health, but if circumstances demand it, it can be done. That’s not the case if the cash is used to buy stock or make ill-advised acquisitions – in those situations the money is gone for good. Last time we checked, no one ever had to take a writedown for a dividend payment.

Complacency about the issue should only go so far, however. Bondholders are at immediate risk if companies are willing to sacrifice ratings in order to appease shareholders. S&P did not mention the issue in its latest action on DPL, but it delivered a downgrade just eight days after DPL increased its dividend by 2%.

However, the trend is more likely to constrain further upgrades than generate downgrades, as the cash being used to fund the dividends is not typically being borrowed and is frequently being diverted from debt repayment. So perhaps the more salient question is what will be the effect of the trend at a company level on overall enterprise value. And the answer to that seems to depend very much on the company itself and what they are communicating to investors.

In the consumer sector there has not been a general trend to increase dividends despite increasing cash balances. Companies are still making the argument that they wish to maintain financial flexibility given constrained organic growth prospects and operational difficulties (in other words, they’re not going to pay away a war chest that could be used for future acquisitions). Given that many consumer names have underperformed on the equity front, stockholders seems to be placated by the existence of relative upside in the sector.

But in sectors such as telecoms, the issue seems to be at the nexus of whether the leading companies can continue to be valued as growth stocks. As the bloom falls off the rosy prospects that once existed in the sector, stockholders are demanding a much greater share of current cashflow.

If, in acquiescing to the demands, the telecoms acknowledge they are value stocks, then the market can be expected to move to pricing them as such and no amount of dividend payments will prevent the adjustment. Those valuations would in most cases be somewhat south of where they are today; and that is a trend that bondholders in those companies should indeed be concerned about.

Louise Purtle is corporate strategist at independent research provider CreditSights

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