Fitch: Leveraged Share Buybacks Ongoing Risk to U.S. Bondholders

CHICAGO/NEW YORK--()--Fitch Ratings believes leveraged share buybacks are an ongoing risk to corporate bondholders as borrowing costs remain at historical lows, but that most buyback activity will continue to be done in a credit-neutral manner. Leveraging buybacks will be most prevalent among mature investment-grade companies with strong cash flows.

Leveraged share repurchase activity moderated in the last 12 months, with seven negative rating actions during this period due at least in part to leveraged buybacks, compared with 12 such actions in 2011. There were also two downgrades in 2012 driven in whole or in part by special dividends, as companies anticipated higher tax rates in 2013.

The pharmaceutical/healthcare and media/telecom sectors have seen the most negative rating activity from share repurchases, reflecting the sectors' relatively stable and cash generative nature. With two exceptions, the downgrades occurred among companies rated 'BBB+' and above, highlighting that this is a risk focused on higher rated companies facing little cost in terms of market access or borrowing rates from moving one or two notches down the rating scale.

Within the pharmaceutical/healthcare sector, the downgrades of Bristol Myers Squibb and Eli Lilly reflected aggressive share repurchase posturing at the same time these companies are facing patent expirations on top-selling pharmaceuticals. The downgrade of Thermo Fisher reflected a more aggressive capital deployment stance that included share repurchases, three acquisitions, and the initiation of a dividend.

In the media/telecom sector, the downgrade of CenturyLink to 'BB+' from 'BBB-' in February 2013 resulted from its initiation of a share repurchase program that will slow the pace of debt reduction over the next two years. CenturyLink was the first downgrade to non-investment grade due at least in part to share repurchases since the downgrade of RR Donnelley in May 2011, underscoring the fact that companies tend to protect their investment-grade ratings.

The downgrade of Dun & Bradstreet was due to an expected increase in debt/EBITDA to over 2.0x as a result of accelerated share repurchases. Fitch also placed a Negative Outlook on AT&T Inc.'s long-term IDR of 'A', reflecting the expectation for higher leverage from a combination of share repurchases and increased capital spending.

The downgrade of ADT Corporation was due to its initiation of a $2 billion, three-year share repurchase program that will be funded in large part by incremental debt. The downgrade also reflected management's willingness to undertake a more aggressive financial strategy following its spin-off from Tyco.

We also recorded two downgrades in 2012 related to leveraged special dividends, as companies were motivated by the specter of higher tax rates in 2013. The downgrade of Costco Wholesale resulted from its $3 billion special dividend that drove lease-adjusted leverage from 0.8x to 1.7x on a pro forma basis.

In addition, SEACOR Holdings was downgraded due in part to a $100 million special dividend. Other companies, including Las Vegas Sands, Limited Brands, HCA, and Brown Forman, also completed sizable special dividends, though these were done in the context of their existing credit ratings.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Contacts

Fitch Ratings
Philip M. Zahn, CFA, +1-312-606-2336
Senior Director
Corporates
70 West Madison Street
Chicago, IL
or
Kellie Geressy-Nilsen, +1-212-908-9123
Senior Director
Fitch Wire
Fitch, Inc.
One State Street Plaza
New York, NY
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Philip M. Zahn, CFA, +1-312-606-2336
Senior Director
Corporates
70 West Madison Street
Chicago, IL
or
Kellie Geressy-Nilsen, +1-212-908-9123
Senior Director
Fitch Wire
Fitch, Inc.
One State Street Plaza
New York, NY
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com