VideoCorporate debt is starting to resemble a financial bomb shelter. But instead of stockpiling waxed beans, investment-grade companies are amassing cash from bond offerings to make balance sheets recession-proof.
Prompted by a weak equity market and lower interest rates, corporate issuers beat last year's record $353.2 billion total in just seven months, reports Thomson Financial. Much of the freshly raised capital is either being hoarded or used to pay down bank debt, says Jack Kallis, a senior vice president at State Street Research & Management, in Boston. "Nothing frightens a CFO more than lack of access to the capital markets," quips Kallis, noting that finance chiefs are stockpiling cash based on flashbacks of Q3 1998, when access to the capital markets was cut off.
The flip side: The downturn has made bondholders more active. Those of Covad Communications Group are collecting $283 million in cash through a prenegotiated Chapter 11 filing. Such hefty cash payouts are rare before a company defaults. Of course, investment-grade firms have a lot more leeway than Covad did, at least for the time being.
-- Marie Leone
REIT OR WRONG?
Much Ado about Spin-offs
To spin or not to spin? The question has led to head-scratching at companies with considerable real estate holdings, thanks to a recent decision by the Internal Revenue Service to approve tax-free spin-offs of such property through real estate investment trusts (REITs). McDonald's Corp. had planned to take advantage of the new ruling, but negative reviews from analysts made the fast-food giant think twice. Credit Suisse First Boston analyst Janice Meyer estimates that the rent payments to a REIT, plus the loss of $1.4 billion in rental income from franchisees, would slice up to $5 per share off McDonald's current earnings.
Such prospects have left another potential beneficiary, Wal-Mart Stores Inc., wary of the idea. "Our earnings multiple is in the 30s, so transferring $1 to a REIT gives you less shareholder value than if that dollar stayed in the operating company," says Wal-Mart treasurer Jay Fitzsimmons.
Perhaps. But Lehman Brothers tax analyst Robert Willens sees it differently. "Anytime real estate comprises several hundred million dollars or more of a firm's assets, a REIT spin-off is doable, and even advisable," he says. "It's a way to convert what would have been tax payments into dividends."
In McDonald's case, Willens says, the idea that cash dividends might be unpopular with investors "doesn't move me at all." In fact, he's predicting the comeback of the dividend as ordinary tax rates come down relative to capital gains rates. Willens is somewhat more sympathetic to Wal-Mart's argument, but counters that the improved returns could boost the parent company's multiple enough to outweigh the REIT's lower multiple.
So the jury is still out on whether the tactic will catch on. McDonald's isn't expected to decide before year-end, and other candidates have only begun analyses. Meanwhile, the IRS says it will continue to be vigilant about the business rationale companies cite for their REITs. And even Willens concedes that "the big hurdle will be convincing the IRS that there are other objectives to be accomplished that outweigh the tax issue."
--Alix Nyberg
CUT 'EM LOOSE
Spin-offs lead to better financing decisions, says University of South Carolina researcher and study co-author Eric Powers. Apparently, capital expenditures show greater sensitivity to changes in growth opportunities after a division goes solo.
COUGH IT UP: Health- care benefit costs for small and midsize companies (10 to 999 employees) jumped 9.2% in 2000, says Marsh.
EXPOSING TAX ABUSE
Shelter Fallout
As political footballs go, tax shelters seem to encourage a lot of punting. But that doesn't mean CFOs can just sit back and watch.
To crack down on abuse, the House and Senate are pushing for tax shelter legislation. But the bills are Clinton Administration holdovers, so politicking ensues. Meanwhile, the Treasury Department refuses to support any legislation until department officials figure out whether their first disclosure-rule filing, due last month, produces the intended result--identification of tax abuse. It could just generate a mountain of reporting on legitimate business operations.
Still, Washington's tax players aren't entirely unserious. For one thing, a July 26 Treasury notice shut down a basis shift shelter that helped U.S. entities avoid tax liability by generating and inflating large paper losses through foreign subsidiaries that recorded stock sales as dividends instead of capital gains. The notice also informs shelter promoters of their obligation to register transactions and keep customer lists. It's still too early for Treasury to calculate the amount of unpaid taxes this particular loophole represented, but the sophisticated scheme was used at least 200 times by multiple taxpayers, both individuals and corporations.
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