(Bloomberg Businessweek) -- The stock market in 2022 has been on a wild ride, as equity investors question whether companies can grow fast enough to justify lofty valuations. But in the junk-bond market, where the attention is focused on a company's ability to pay its bills, the story is a bit different. Several major high-yield borrowers—including Netflix Inc., which has seen its share price cut by more than 25% this year—are close to or have recently won promotion from credit rating companies out of the junk pile and up to “investment grade.”
Netflix along with Dell, Tesla, and T-Mobile took advantage of the long era of low interest rates to borrow billions of dollars relatively cheaply from investors hungry for yield. And then the companies got help they couldn't have expected: The Covid-19 pandemic and the Federal Reserve's aggressive response to it extended the period of low rates and easy financial conditions, giving companies more breathing room to execute their plans.
Earning investment-grade status can allow a company to borrow at lower rates and increases the pool of potential lenders. While new issuance in the junk-bond market can sometimes shut down, the investment-grade bond market almost never does and can provide a steady source of financing even for companies with a lot of debt. “If you go full investment grade, you have much lower capital-access risk when you have refinancing,” says Davis Hebert, an analyst at research firm CreditSights. But with inflation on the rise and interest rates likely to increase, can all of these titans-of-junk-turned-near-blue-chips keep it up?
The question may be most pointed for Netflix and Tesla Inc., because they benefited so much not only from low rates but also from their high stock valuations, which are now slipping. But credit analysts say both have made progress.
Borrowing was an essential ingredient to building today's Netflix, which some detractors have called Debtflix. The company's debt excluding leases ballooned from just shy of $1 billion in 2014 to more than $16 billion in 2020, with its last bond deal closing in April of that year. Netflix needed the money to shift from licensing content to becoming one of the world's biggest studios. Fixed-income investors took comfort in the company's high stock price. “Even if people questioned the market cap, it gave them some belief there was some underlying value there,” says Hunter Martin, another CreditSights analyst. In essence, bond investors could assume that even if things went bad, the company would be able to find a buyer for its assets or raise cash from selling equity long before its debt would be in danger.
When the pandemic hit, Netflix's abundant content positioned it to become one of the main ways people spent their free time at home. Subscriber numbers climbed past 200 million, helping lift market value even higher, to more than $300 billion in late 2021, up from about $25 billion when the borrowing binge began.
This year, Netflix is facing much more skepticism from stock investors, and its market value has fallen recently to below $200 billion. Subscriber growth in 2021 was about half that of the previous year.
The stock slide along with rising interest rates could cost Netflix if it seeks to add more debt, but the company is past that phase unless circumstances change. Last year, Netflix said it would no longer need to borrow money to fund day-to-day operations and would target debt levels from $10 billion to $15 billion going forward. Increased subscriptions and a pause in production costs as the pandemic shut down filming allowed Netflix to record positive cash flow in 2020, earlier than originally planned, and it expects to achieve that on a regular basis starting in 2022. S&P Global Ratings already upgraded Netflix last year to blue chip, and Moody's Investors Service rates it just one step below with a positive outlook, meaning an upgrade is likely.
A booming stock was even more important to Tesla. The company only had to dip into the junk- bond market once before turning to die-hard fans to raise equity to fund new car models and factories, and it's since paid off that debt. Tesla borrowed $1.8 billion in 2017, when it was strapped for cash as it burned through billions of dollars to design and produce new models of cars. By 2018 there was a legitimate risk of Tesla running out of money, but it turned around its fortunes by increasing sales and later rolling out the Model Y.
Then came Covid. The Fed's actions combined with a huge economic rescue package from Congress helped to fuel a stock market boom, just as the explosion of zero-commission trading apps pulled more retail investors into the market. Tesla's household name and its meme-worthy chief executive, Elon Musk, attracted many ordinary investors, helping win the company a place on the S&P 500. Its market value rose to a peak of more than $1 trillion in November, from about $80 billion at the start of 2020. Tesla raised $10 billion in two stock offerings in the second half of 2020, following a string of smaller share sales. “The stock having a meteoric rise enabled them to raise billions of dollars of capital,” says Dan Ives, an analyst at Wedbush Securities.
Tesla has climbed to the cusp of investment grade all the way from the deep junk territory it reached when it sold the bonds in 2017. It's expected to achieve investment grade next year. (Generally, companies are considered investment grade when at least two of the three big credit raters say so.)Established automakers such as Ford Motor, General Motors, and Toyota Motor are spending briskly to build their own fleets of electric vehicles, putting competitive pressure on Tesla. Still, even after a 14% decline in its share price this year, the company has the highest market value, at more than $900 billion, of any carmaker in the world. That gives it a lot of options for raising cash.
For T-Mobile US Inc., the pandemic was a story of twists and turns. The wireless carrier relied on bonds over the years to fund purchases of spectrum rights, crucial to building out wireless networks, and the company planned to do so again to help pay for its acquisition of Sprint. But the deal had the bad luck to be slated to close on April 1, 2020. This was around the height of Covid market turmoil, so it was a tricky moment to be issuing new corporate debt. To ensure the Sprint deal would go through, a group of banks loaned $23 billion to T-Mobile, a just-in-case measure that had previously been negotiated. It was the largest bridge loan of its kind to get stuck on banks' balance sheets since the 2008 financial crisis.
But the banks were able to sell the T-Mobile loan to institutional investors almost immediately. In the days leading up to the acquisition, the Fed had been working overtime to keep debt markets running. It had even offered to buy corporate debt in a pivotal announcement on March 23, which boosted investors' confidence in bonds generally.
T-Mobile has outperformed expectations for integrating with Sprint and has increased the amount of money it expects to save from combining the companies. It already has some access to the investment-grade bond market by backing certain debt with assets. For the company overall, Fitch Ratings Inc. has upgraded T-Mobile to blue-chip status, and Moody's and S&P could do so soon, meaning the company will join peers AT&T and Verizon.
Dell Technologies Inc. is proof that slow and steady can win the race. It regained investment-grade status in 2021. The technology company fell to junk when founder Michael Dell and private equity firm Silver Lake Partners used debt to take it private in 2013. Then it took on tens of billions of dollars of more debt for its takeover of EMC in 2016. Since then, Dell has chipped away at its debt load, and the rush to work from home in 2020 spiked sales growth. It's also spun off VMware, giving it the cash to pay down enough debt to regain investment-grade status.
These four big borrowers may have done their deals and spruced up their credit ratings in the nick of time. Debate is now raging over just how much, and how fast, the Fed will raise interest rates and cease bond purchases. For now, investors are still willing to offer credit relatively cheaply. “Any asset manager will tell you that they're not getting paid to sit on cash,” says Lyuba Petrova, head of the leveraged finance group at Fitch. Even six quarter-point increases this year would bring the Fed funds rate to only about 1.5%, right around pre-Covid levels. But if inflation worsens and economic growth stays strong, the central bank could take stronger actions—and more than a decade of easy money could finally end.
In that case, the next cash-burning Netflix or acquisitive T-Mobile might have to think twice before borrowing. This might not be an entirely bad thing: Office-sharing company WeWork borrowed $702 million from investors in 2018 to fund rapid growth, then fell from grace the next year. But you can add corporate America's access to debt to the list of worries weighing on the Fed as it contemplates its next steps.
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