Banking & Capital Markets

CFOs See Swell Numbers in 2002

Survey: Corporate earnings to rise an average of 10 percent. Also: companies debt while the debting's good, plenty of downgrades, and do trans-Alta...
Stephen Taub and John GoffMarch 25, 2002

Finance chiefs see better times ahead. Much better times.

According to the latest quarterly survey conducted by Financial Executives International and Duke University, CFOs expect a major economic turnaround this year. Specifically, the finance chiefs surveyed see a 2.3 percent growth in GDP earnings this year. That translates into a 7.2 percent increase in the S&P 500 Index in 2002.

Perhaps the most interesting response from CFOs: 88 percent of the surveyed finance chiefs predict earnings improvement at their companies. On average, the CFOs say they’re expecting a 10 percent increase in income at their respective companies. CFOs in the transportation/energy and retail/wholesale sectors see a smaller jump-up in corporate earnings.

“CFOs are optimistic about the U.S. economy and earnings over the next twelve months,” says John Graham, finance professor at Duke’s Fuqua School of Business and director of the survey. “However, they recognize that their companies are just now beginning to bounce back.”

Asked about their companies’ current conditions, about a quarter said their businesses have not begun to recover from the recession. But nearly six in ten said their companies are currently in some stage of recovery: 40 percent reported their recovery is just beginning, 12 percent said their companies have recovered moderately, and 7 percent are nearly fully recovered. Interestingly, 17 percent of the CFOs noted that their companies never slowed down, even during the 2001 recession. Judging by the survey, the manufacturing industry is still suffering the most, with 36 percent of the respondents stating their companies have not recovered at all.

Also of note: the FEI/Duke study revealed that accounting standards need some work. Indeed, 52 percent of the respondents think that current disclosure rules do not adequately serve investors.

Interestingly, nearly nine out of ten of the surveyed CFOs believe financial disclosures should be made easier to understand. And 47 percent said they think companies should be required to get financial information to investors faster.

Lock of the Rate

With press reports coming out daily that Federal Reserve Chairman Alan Greenspan is going to raise the Fed funds rate this summer, major corporations are scrambling to lock in historically low interest rates while they still can. And it appears fixed-income investors are snapping up this paper the way equity investors raked in tech stocks during the late 1990s.

Case in point: General Electric Capital’s bulked-up bond offering. The captive finance arm of GE issued a whopping $11 billion in global bonds. The GE Cap offering was the second largest bond issue ever by a U.S. company, out-distanced only by WorldCom Inc.’s multi-currency $11.9 billion borrowing last May. The GE global underwriting was also the fourth biggest corporate funding worldwide.

Initially, management at GE Cap had planned to borrow $6 billion from lenders — a sizeable amount by any standard. As it turns out, the captive finance unit received at least $15 billion in bids for its paper, according to Reuters.

The GE Cap offering consisted of three tranches. The company offered $4 billion of three-year, floating-rate notes yielding 0.125 percentage points over the Libor three-month mark. GE Cap also issued $2 billion in five-year notes yielding 5.395 percent, as well as $5 billion in 30-year bonds yielding 6.844 percent.

It’s easy to understand market interest in the offering. GE Capital is a sterling credit, and lenders have been burned of late by big name companies going bust (Global Crossing, Kmart, and Enron, to name three). GE Cap’s debt is rated AAA by Moody’s and Standard & Poor’s. Company management told Reuters it would use the funds for general corporate purposes, including replacing existing debt “in support of asset growth.”

J.P. Morgan, Lehman Brothers Inc. and Salomon Smith Barney were the lead bankers on the mega-underwriting.

But GE Cap isn’t the only company supersizing a bond offering of late. Management at Ford Motor Credit increased its recent global bond offering, adding $2 billion to the company’s existing global notes facility. The captive finance unit added $1 billion to its 6.5 percent notes, which are due in 2007. Ford Motor Credit also added $1 billion to the company’s 7.25 percent notes. In case you’re planning ahead, those notes are due on Oct. 25, 2011.

In addition, CRH America Inc. upped its global deft offering. CRH America, a unit of Dublin, Ireland-based construction materials supplier CRH Plc, issued $1 billion in 10-year global notes. The $1 billion was a third more than CRH management had expected to raise. The paper was priced to yield 6.964 percent, or 170 basis points over comparable Treasurys.

And finally, Constellation Energy Group borrowed $1.8 billion in a three-part debt offering last week. Keeping with our theme: the company had originally planned to raise $1.5 billion. Constellation issued $600 million in five-year notes, $600 million in 10-year notes, and $600 million in 30-year bonds. The three tranches were all rated Baa1 by Moody’s and BBB-plus by S&P.

Survey: Trans-Atlantic Deals Are Winners

Now here’s some surprising news.

According to a recent Mercer Consulting Group study, the majority of large trans-Atlantic mergers completed between 1994 and 1999 — 82 of 152 deals studied –outperformed industry market value benchmarks. Over the years, most M&A studies have concluded that these sorts of U.S/European deals typically don’t work out.

But Mercer’s study reveals that, during the 1990s, the number of trans-Atlantic deals and the size of the transactions averaged 30 percent annual growth. European-led deals outnumbered American-led deals by more than 50 percent.

“Success” was calculated as the market value growth of the acquirer — from one month pre-announcement to 24 months post-announcement — as compared to the market value growth of its corresponding industry index over the same time period.

So why did these trans-Atlantic mergers work? Mercer said that in interviews with senior executives who successfully completed these kinds of deals, a number of them pointed to post-merger integration as the key to success.

“Most trans-Atlantic deals are expected to face greater regulatory and cultural barriers,” said Mike Lovdal, a Mercer Management Consulting vice president who directed the research effort, in a press release. “That leads to a more careful integration process.”

Lovdal added that corporate governance structures, shareholder interests, and regulatory philosophies affecting many trans-Atlantic deals “form a natural screen for poorly conceived deals to get weeded out.”

Mercer said it looked at other possible drivers of performance but found little or no bearing on M&A performance resulting from the premium paid, pre-deal performance of the acquirer, relative size of the parties involved, or strategic intent.

“Most trans-Atlantic deals are driven by expectations of revenue growth, but this is much more difficult to achieve than cost savings,” said Lovdal, adding that “post-merger integration in successful deals has been focused on revenue-related issues such as customer communication, sales channels, and brands.”

I Am Jane’s Downgrade

The ratings agencies have been busy of late. Both Moody’s Investors Service and Standard & Poor’s have lowered the credit ratings of several high-profile corporates. Here’s a roundup:

>> On Friday, Standard & Poor’s lowered the debt rating of Reader’s Digest to junk status. S&P dropped the publisher’s rating to double-B-plus after the company announced it was acquiring Reiman Publications for $760 million.

In explaining the downgrade, S&P noted the purchase of Reiman will dramatically increase the debt-load of Reader’s Digest at a time when the publisher’s core businesses are suffering. Reiman publishes a host of magazines, including Taste of Home, the top selling food magazine in the U.S., and Birds & Blooms. Birds probably like that one.

>> Moody’s also cut its long-term debt ratings of Lucent Technologies two notches, to B2 from Ba3 for senior unsecured debt, and to Caa2 from B3 for preferred stock. The rating agency also assigned a Caa1 rating to Lucent’s recent issue of trust preferred stock and a B2 senior implied rating.

Lucent issued those convertibles in a private placement last week. The networking specialist offered $1.75 billion of what are termed “cumulative convertible trust preferred securities.” Managers at Lucent had planned to raise $1.5 billion with the offering. The securities are convertible into Lucent common stock at a conversion price of $6.10 a share. That’s about a 24 percent premium over the recent closing price of Lucent shares.

Moody’s was not impressed. “The rating actions reflect the continuing cutbacks in capital spending plans by Lucent’s core customer base and the expectation that the downturn in demand will be more protracted and deeper than we had previously anticipated,” the rating agency said in a statement.

“As a result, the company’s return to profitable operations, even at the Ebitda level, will be delayed and cash outflows will continue for an extended period.”

>> Moody’s downgraded Brunswick Corp.’s senior unsecured long-term rating to Baa2 from Baa1. In a very long sentence Moody’s said the downgrade “reflects the rapid margin erosion in its business segments that has occurred as a result of falling demand and actions taken to address it, as well as our expectation that debt protection measure are not likely to improve significantly given the anticipated slow rebound in demand and the likelihood that the company will continue to use its free cash flow to make tuck-in acquisitions rather than to reduce debt.”

>> Moody’s lowered the ratings of Toys R Us saying the downgrade reflects a combination of factors that have increased the seasonality of the retailer’s profit generation and the risk of a weak fourth quarter. Among those factors: Increased competition in toy retailing, the expense associated with converting stores to its Mission Possible format, ongoing losses at, and continuing difficulties at Kids R Us.

>> Meanwhile, Moody’s cut Eastman Kodak’s long-term debt rating to Baa1 from A3 — but said the outlook was stable. The rating agency also affirmed Kodak’s short-term rating, which was not under review, at Prime-2.

Junk Default Rate Finally Drops

Moody’s reports the global, 12-month default rate for junk bond issuers fell in February. All told, 10.54 percent global high-yield issuers defaulted on their payments last month. That was down from the 10.68 default rate in January, which just happened to be an 11-year high. Moody’s says the junk default rate is likely to head lower as the U.S. economy improves, ending up at around 7.4 percent by year’s end.

Interestingly, U.S. high-yield issuers continue to default more often than their cross-border counterparts. In February, 11.2 percent of U.S. junk-bond issuers couldn’t make their scheduled payments. Still, that’s down slightly from the 11.4 default rate in January.

Financing Short Takes

Shares of Travelers Property Casualty Friday closed up more than 5 percent, at $19.56 on Friday, on their first day of trading. The spin-off of Travelers, a unit of Citigroup, was the largest ever IPO of a U.S.-based insurance company. Travelers raised nearly $3.7 billion in the offering.

Computer Associates International Inc. issued $660-million worth of notes a private placement. CA may have had some problems of late, but raising capital doesn’t seem to be one of them.

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