Junk-Debt Apocalypse Later

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Barron’s assuaged our fears about junk bonds. “High yield is likely to be relatively safe and offer decent yields for the next year or two.” A year or two? And then what? Ah… “But risks loom as the credit cycle stretches out and the long-expected rise in rates materializes.”

Everyone gets out in time. That’s the idea. Everyone, all at once. With no buyers at the other end because everyone is getting out, rather than in. But Barron’s was right, even if the timing doesn’t work out: whatever mayhem awaits us in the future, at the moment we’re having fun.

Possibly the most fun ever:

Charter Communications’ offer to buy the much larger Time Warner Cable for a red-hot $78.7 billion comes on top of its previously announced but now amended deal to buy Bright House Networks for $10.4 billion. But that deal suddenly requires an additional $2 billion in debt, as Charter disclosed in an SEC filing. In order to pull both deals off, Charter would likely have to issue over $25 billion in new debt.

Charter has already lined up some of its ducks in a row. This is the greatest credit bubble in history, and money for deals is sloshing through the system in utter abundance. According to Bloomberg, Bank of America, Credit Suisse, Goldman Sachs, and UBS have committed to provide $31 billion to fund the purchase.

Thing is, Charter is junk-rated. Moody’s rates it Ba3 – three levels below investment grade. And these two deals would turn Charter into one of the largest junk-debt issuers ever, or possibly, when it’s all said and done, the largest one.

The largest-ever junk-debt deal so far was the leveraged buyout of TXU, the biggest electric utility in Texas, masterminded by KKR, TPG Capital, and Goldman Sachs, at the very tippy top of the prior bubble in October 2007. The “smart money” made a bet: TXU, which relied heavily on coal-fired power generation, would gain a competitive advantage over the gas-fired power plants of its competitors as the price of natural gas would soar because the US would run out of gas and would have to import much of it as LNG at high international prices.

But as the US fracking boom took off, the price of natural gas crashed, the hoped-for cost advantage of coal over gas disappeared, and the mountain of junk-rated debt crushed TXU. In April a year ago, Energy Future Holdings, as TXU has been renamed, declared bankruptcy “to create a sustainable capital structure to better support our high-performing operations.”

Below-investment-grade debt is called “junk” for a reason. If the hoped-for synergies and pricing bets and imaginary growth trajectories don’t pan out in these deals – and they rarely if ever do – then all heck breaks lose down the road. But not now. TXU’s road to bankruptcy took seven years.

These glorious junk-rated mega deals are only possible in full-blown credit bubbles. As they say in banking: bad deals are made in good times.

So Charter is joining good company of mega junk-debt issuers. Charter’s bet is that these acquisitions will almost quadruple its number of cable subscribers who will then take care of the mountain of debt, and it’s hoping that cable-cutting doesn’t become a national passion.

TWC, which Moody’s rates at the lower end of investment grade, already has $23 billion in gross debt. But since it is being acquired by a junk-rated company with much more leverage, Moody’s put TWC’s debt on review for a downgrade:

The review for downgrade reflects its intention to merge with a lower-rated and more leveraged entity, which given the financing plans which include a significant debt component, will lead to deterioration in the newly combined TWC, Charter and Bright House’s balance sheet strength and credit metrics to a level not consistent with a family investment grade rating.

We estimate that the deal could leave the combined entity with a debt burden (gross unadjusted debt) in excess of $60 billion and pro-forma debt-to-EBITDA (incorporating Moody’s standard adjustments) of approximately 4.5x, compared to TWC’s current outstanding gross debt of $23 billion and adjusted leverage of 3.0x.

Charter granted existing TWC bondholders security, thereby increasing the proportion of secured debt in the capital structure. Which made Moody’s nervous. It now “anticipates that the review will result in a multi-notch downgrade of TWC’s long-term debt ratings below investment grade status.” A downgrade to junk.

Standard & Poor’s also placed TWC’s senior unsecured debt on CreditWatch with negative implications.

And here, according to Bloomberg, is what happened next:

Time Warner’s bonds jumped by the most in more than a year after Charter announced its plan to purchase the company. Time Warner’s $1.25 billion of 4.5 percent notes coming due in September 2042 gained 9.5 cents to 88.3 cents on the dollar to yield 5.5 percent…. Its $1.5 billion of 7.3 percent bonds maturing in July 2038 posted the biggest gain, with a 11.7 cent increase to 114.3 cents….

Let the good times roll. All asset prices will rise forever. Money is still nearly free. Be happy, don’t worry. Thank you halleluiah, Fed, for these wondrous times. The apocalypse has to wait.

Alas, the good times have been rolling for a very long time, and many promises to pay are now unsustainable. This is where the vast US municipal bond market gets very messy. Read…  Schwab Warns on Munis, those “Affected by Pensions” Are Toxic

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  9 comments for “Junk-Debt Apocalypse Later

  1. robert h siddell jr
    May 27, 2015 at 11:43 am

    After the Dollar Crash, all debt will become Junk Debt!

  2. Petunia
    May 27, 2015 at 12:00 pm

    This deal looks like a CDO squared with the underlying assets being companies instead of houses. Just like a CDO squared the merger of two companies in trouble will create a glorious new entity with an impressive new rating. They have run out of ideas. The outcome will be the same.

  3. Julian the Apostate
    May 27, 2015 at 12:15 pm

    Every day I think it can’t get any squirrelier and every day the next article that trumps the last. It’s like we’re playing Pinochle and the cards are all trump cards and Jokers are wild. Yeeeesh.

  4. Alf
    May 27, 2015 at 12:24 pm

    So Goldman shorts this stock and makes billions??

  5. Vespa P200E
    May 27, 2015 at 12:24 pm

    I was once Charter shareholder and sold it when it was trading down to I think $2 level many years ago then BK in 2009. I sort of put my money with Paul Allen and got burned…

    So the truly POS Charter arising from BK 6 yrs ago is issuing more questionable junk bonds thanks to banksters (who no doubt made a killing on these offerings) to con next round of muppets?

  6. mick
    May 27, 2015 at 2:06 pm

    How do you pick a top?

    When a deal like this goes down. It takes a deal so nutbar that a segment of the insane asylum is shaken from its insanity. That starts the ball rolling….

  7. VegasBob
    May 27, 2015 at 3:11 pm

    Don’t forget that the debt of another failed LBO, Caesars Entertainment (formerly Harrah’s Entertainment), is now worth pennies on the dollar due to the Caesars bankruptcy filing in January 2015.

    When all is said and done, about $10 billion of their $18 billion in debt will be written off.

  8. Neil Dunn
    May 27, 2015 at 6:40 pm

    In todays WSJ page B2 is an article on “debt worries” about this merger. Debt burden, junk bond status, and other stuff is mentioned, but TWC CEO RobMarcus (in line for a $97 million separation package) said, “…I’m very comfortable with the value delivered to TWC shareholders”. The gloom and doom just is not there. Your analysis is a major factor influencing me to cancel my subscription to the WSJ Good-Times Bubble Express.

  9. MC
    May 28, 2015 at 1:32 am

    There’s one thing that keeps bugging me about these debt-fueled mega deals.
    The two headed snake allowing them to be even imagined is cheap credit on one end and desperate demand for any scrap of yield on the other.
    We all know cheap credit, so let’s concentrate on yield.

    Let’s be honest here: the only reason fracking outfits and companies such as Charter are even able to sell all those junk-rated bonds is demand for yield from everybody, be them retail investors or mutual fund managers.
    Junk rated bonds once had their place, but they were not the prime yield instruments in a portfolio. With perfectly safe sovereign and corporate bonds yielding 4% who needed a ton of junk with double digit yields?
    But now… junk bonds have pretty much become the prime cash cows in many portfolios. Is this dangerous? Absolutely. Is this irresponsible? Yes, but if for one reason or another you need more than the microscopic yields safe bonds pay, you have no alternative. That was the final intended goal of financial repression: price risk out of the system and hence drive sane people into extremely dangerous “investments”.

    Let’s back to Charter now. Let’s say their deal go through as expected and, to achieve this, they issue $25 billion in bonds, yielding an average 4%.
    Do you know what 4% of $25 billion is? A cool one billion a year just to service those bonds! And this is without taking into account the fees and interests Charter will have to pay Goldman Sachs, Credit Suisse and the rest of the banks that will facilitate and help financing the deal. I think when all is said and done buying TWC and BHN will cost Charter something in the $2 billion ballpark each year. And this is on top of what Charter already pays now and what it will inherit from TWC and BHN if the deals go through.
    I don’t know about you, but it seems to me like a snake attempting swallowing an elephant whole: Charter is not Exxon-Mobil, Apple or GE.

    If there’s one thing Japan’s “Two Lost Decades” taught us is that financial repression will only carry you so far. Before the BoJ embarked in its scheme to purchase every Japanese sovereign bond that isn’t welded in place (they have a big monetary crowbar for those which are nailed down), Tokyo saw something between 25 and 30% of its tax revenues go up in smoke each year just to service its debt… a debt which carried minuscule yields, often under 1%.
    Charter is not the Japanese government: they have no power to increase taxes. They have no central bank coming to the rescue. They have no captive market for their products: TWC has some pretty stiff competition and the junk bond market is crowded at the moment, and will soon be even more crowded (China will soon swamp the world with debt as she did with cheap consumer goods: what we’ve seen so far was just the warning shot).
    In short they are left at the mercy of fate. For one or two years, there may be smooth sailing, albeit in slightly rough waters, but sooner or later the financial repression effect will end. With inflationary expectations ramping up (apparently very rich people have started buying their own groceries and noticed deflation is a myth, like precision bombing), investors will demand higher yields, no matter what central banks do and say.
    Not much is needed: yields going from 4 to 6% are enough to add 50% to debt servicing. Outfits like Charter will be so heavily leveraged they will feel something more than a pinch.

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