Capital Markets

More Equity, Less Debt: It’s All Good

Expect to see a stronger correlation between equity issues and credit upgrades in 2002.
Alix StuartJanuary 21, 2002

Looking to boost your company’s credit rating? Try issuing equity, and then use the proceeds to redeem or refinance debt.

Moody’s Investors Service reports that 24 companies saw upgrades at least partly stemming from the injection of common equity capital as of Q4 2001. In 2000, only 15 companies witnessed the trend. And expect to see the correlation between equity issues and credit upgrades strengthen in 2002, particularly after equity market firms buy enough to spur a broad-based recovery by initial public offerings, notes John Lonski, Moody’s chief economist.

In theory, the strategy indicates that these companies are favoring debt holders over equity holders, a practice that doesn’t sit well with Wall Street. But CFOs who have engineered the move say the promise of a stronger balance sheet has swayed even growth-oriented equity investors.

“To say the two constituencies are in direct conflict is an overstatement,” says Richard Navarre, CFO of Peabody Energy, one of the world’s largest coal providers. “They both want a strong, healthy company.” Peabody’s $452 million IPO in May was 20 times oversubscribed and priced $10 above its initial range, even though investors knew all proceeds would go to pay down debt. Purchased through a leveraged buyout three years ago, Peabody shrank its debt-to-equity ratio from 80 percent to 47 percent within two years with the IPO. However, mindful of growth, Navarre emphasizes that Peabody invested $124 million in capital projects during the first six months of 2001.

For non-LBO companies, a bald request for cash to pay off debt may not fly, say some pundits, but equity investors are not unsympathetic to such plans if they’re coupled with the right growth prospects, notes J.P.Morgan equity analyst Corey Davis.