The majority of investment-grade entities that are spun or split off from investment-grade companies are likely to maintain investment-grade ratings, Moody’s Investors Service concludes in a new report.
Most entities that are separated from investment-grade companies receive a speculative grade rating at the outset, reflecting their often aggressive capitalization and heavy debt burden. But of 44 investment grade spinoffs and splits since December 1999 that Moody’s examined, 33 retained investment-grade ratings while 11 were downgraded.
Of the 33 companies that maintained investment-grade ratings, 10 were upgraded over time; 20 maintained the ratings they received at the outset; and three were downgraded, though they retained investment grade ratings.
“While there’s a high likelihood a new spun-off entity will sustain an investment-grade rating, many of these companies face additional challenges,” Moody’s Senior Vice President Gerald Granovsky said in a news release. “Despite having a strong initial credit profile, corporate spinoffs often receive increased pressure from shareholders.”
As far as the 11 investment-grade corporate spinoffs that subsequently fell to speculative grade, “they were often created in the midst of an uphill battle against industry changes and were unable to overcome massive market shifts affecting their business,” Granovsky said.
Those market shifts include the bursting of the tech bubble in the early 2000s. Conversely, only three companies lost their investment-grade status because of shifting financial policies, indicating that most of the spinoffs kept their commitments to maintain a healthy financial profile.
As with most investment-grade companies rated by Moody’s, spinoffs’ capital structures tend to lend themselves to mid Baa ratings. Only two companies in the Moody’s sample received a rating above Baa1, despite many being separated from companies rated A3 and higher.
“This speaks to the loss of scale and diversification that supports very strong ratings,” Moody’s explained.
Going forward, the ratings service predicts that increased shareholder pressure on newly independent companies will be an additional challenge to maintaining investment-grade ratings.