After a decade of gorging on cheap money, indebted companies are looking at selling off chunks of their businesses as they fortify their balance sheets for the new era of higher interest rates.
Banks were tightening credit availability even before the demise of Silicon Valley Bank and Credit Suisse Group AG, one factor that’s pushed some firms to pause dividends, raise equity and turn to discounted bond buybacks to reduce leverage.
Other corporates are taking more dramatic steps by turning to disposals, an option that’s expected to grow in importance as borrowing costs remain elevated. About 44 percent of US chief executive officers are planning divestments this year, according to an EY poll.
“That is a tool that we have seen a little bit, but we think it is going to be more prevalent going forward,” said Greg Berube, a senior managing director at Evercore Inc.’s restructuring and capital markets advisory group. It’s “a way to essentially inorganically deliver your balance sheet to help with your refinancing risk.”
It’s a marked reversal from the past decade, when lenders and shareholders urged firms to increase borrowings and buy other businesses to take advantage of super-cheap funding. The cost of money was so low that companies were even borrowing to boost their share price through buybacks. At one point, more than 30 percent of those purchases in the U.S. were funded by debt, JPMorgan Chase & Co. data show.
Companies that sold or are selling assets to cut debt include:
- Rolls Royce Holdings Plc sold a Spanish aircraft engine manufacturer last year as part of a £2 billion disposal program, using most of the funds to rebuild its balance sheet
- Baxter International Inc. said in January it’s considering a sale or separation of its BioPharma Solutions business, and some proceeds could be used to repay debt
- Vodafone Group Plc disposed of a stake in its Vantage Towers AG business to a consortium that includes KKR & Co. as part of its deleveraging efforts
- Aramark is selling its 50 percent stake in AIM Services for $535 million and will use the proceeds to cut its debt. Chief executive John Zillmer told analysts the firm “will continue to identify these types of opportunities, specifically in areas where we have a non-controlling interest”
In Italy, power company Enel SpA is in the midst of selling €21 billion ($22.8 billion) of assets to cut last year’s record debt pile, which was built up to fund the transition to renewable energy.
CEO Alberto de Paoli said it’s aiming to get its leverage ratio — debt to earnings before interest, tax, depreciation and amortization — down from about 3.1 times.
“We worked for years at 2.5 times leverage, until 2020. Every time we were talking with funds, banks and investors, they felt we were somehow underlevered,” de Paoli said in an interview. “There will be a situation now where some will say the level of debt is too high. We are driving to go back to 2.5 times. That’s the best level for a company like this to have.”
Economic Risks
The economic fallout from the corporate debt mountain has long been on the radar of central banks, which have repeatedly warned that it could amplify any downturn.
Just this week, the Bank of England highlighted the threats to financial stability from corporate credit levels.
“The current uncertainty cycle” will “support a longer phase of large conglomerates looking to refocus management time on fewer operations,” said Mitch Berlin, vice chair at EY America’s strategy and transactions division. “This cycle will result in more spin offs in 2023 and will likely continue through 2024.”
Companies with high debt loads are caught in a tight place right now because if economies prove resilient, that could mean faster inflation and higher borrowing costs for longer. On the other side, weaker growth – or worse, a recession – would hit sales and profits, denting capacity to pay interest costs.
One headache faced by those looking to sell units is that traditional lenders are much less willing to finance purchasers after a spree by private equity firms in the aftermath of Covid-19.
Banks were left with billions of dollars of risky corporate loans when interest rates rose sharply last year, making many unwilling or unable to write large checks.
That, in turn, means private equity has fewer financing options, hurting their ability to do acquisitions. Deal values by those firms are down 56 percent to $143 billion so far this year compared with the same period in 2022, according to data compiled by Bloomberg.
Some private equity firms and corporates will look to sell businesses before the wave of cheap borrowings built up over the last few years comes due for repayment.
“Most of the deals in our industry are levered transactions,” said Marco De Benedetti, co-head of Europe private equity at Carlyle Group Inc. “Those financings have maturities, and today to refinance the cost of capital is approximately double 2021 rates. That is another trigger to induce people disposing before hitting the maturity wall.”
Valuation Decline
The median valuation multiple for corporate M&A deals globally has fallen about 34 percent since 2021, according to Bain & Co., based on data comparing enterprise value with EBITDA.
With credit also harder to get, some firms have turned to seller financing, where they offer a buyer some of the funds to get a deal done. Emerson Electric Co., for example, loaned money for Blackstone Inc.’s takeover of its $14 billion climate technologies unit.
Meanwhile, when J.M. Smucker Co. put several pet food brands up for sale, it knew that a strategic buyer would offer more certainty and possibly a higher price than a private equity purchaser right now, CFO Tucker Marshall said in a March 7 interview.
The company, which owns Uncrustables, Folgers and Bustelo, last month agreed to sell some of the pet food brands for about $1.2 billion. It plans to use about $700 million for share repurchases, leaving as much as $500 million to pay down debt.
Smucker currently has a ratio of net debt to EBITDA of 2.8 and is targeting a ratio of 2.5, Marshall said. That would give sufficient borrowing capacity for an acquisition of its own, subject to metrics including the cost of borrowing.
“The cost of an acquisition has gone up, particularly the funding of an acquisition,” Marshall said. “That could potentially put a little bit of pressure against the multiple that we could offer.”
