This morning’s “Heard On the Street” column in the Wall Street Journal carried a story that could mean big trouble for private equity firms—the increased tolerance for piling up debt in public companies.
A number of public companies are taking a leaf out of the playbook of private-equity firms and loading up on debt to improve returns for their shareholders. In doing so, they are taking on more risk and making big bets that they will stay profitable for years to come.
The credit markets have been hospitable to most fund-raising efforts, though there are signs that debt investors are becoming less accommodating and are starting to push corporate interest rates higher.
During the past few months, Domino's Pizza Inc., Health Management Associates Inc. and Dean Foods Co. also unveiled plans to take on significantly more debt and distribute much of their cash to shareholders through dividends or one-time share buybacks. That is resulting in higher "leverage," or the amount of debt relative to the cash the companies generate each year.
Proponents of such "do-it-yourself buyouts," also known as leveraged recapitalizations, say they make public companies more efficient and may help increase their bottom lines in the long run. In transactions that involve buying back shares, corporations also shrink the number of shares they have outstanding, making the per-share earnings they report look better.
The first question that occurs, of course, is whether public shareholders have developed the taste for debt that has helped private equity make so much money. Or, to put it differently, are there are still a lot of debt-loathing Horatio’s out there to guarantee permanent debt opportunities for private equity? We're pretty sure that as long as writers for Time magazine regard the operations of private equity as "abracadabra" the answer is yes.
But the second question is whether lenders themselves can impose the kind of discipline needed to handle the increased leverage. The lenders are bettting the answer is yes but it's not clear that the managers of public companies have the longer term outlook and micromanaging supervision that makes private equity companies comfortable with increased amounts of debt.
How Borrowing Yields Dividends At Many Firms [Wall Street Journal]