Teva Shows the Flip Side of Rapidly Growing Leverage

(Bloomberg Gadfly) -- It's easy to dismiss warnings of growing corporate leverage as an abstract concern of little near-term consequence.

But on Thursday, Teva Pharmaceutical Industries Ltd. gave a real-life example of the pitfalls of using borrowed money to juice profits. If revenues don't increase quickly enough, the downside is fast and furious. This is true years in the future, when borrowing costs go up, but it is true even now, in a low-yield world.

Teva slashed its earnings goals for a second time this year, cut its dividend and said it might violate some of its debt covenants if sales don't rise. This comes after the world's biggest maker of generic medicines packed on roughly $35 billion of debt as it sought to dominate all facets of cheaper, copycat drugs, including a $40.5 billion acquisition of Allergan's generics business last year. In hindsight, the purchase was inauspiciously timed given the continuing pressure on these drug prices and lower margins.

Teva is now getting dangerously close to a downgrade, with S&P Global Ratings warning last month that it might downgrade the company's BBB debt if it lost faith that Teva could reduce leverage toward about four times over the next two years. The company said its debt-to-Ebitda ratio rose to 4.65 times in the second quarter, citing foreign-exchange fluctuations.

The reaction was quick. Teva's bonds plunged Thursday. The company doesn't just face more expensive refinancing costs; its ability to acquire more companies or take other potentially lucrative risks has been seriously hampered.

Teva is an extreme case of a company rapidly increasing its debt load, but it's hardly alone. For the past few years, it has been all the rage for corporations to borrow as much money as they possibly can while rates are near record lows. You can see this among U.S. investment-grade companies as well as emerging-market issuers such as Teva, which is based in Israel.

The total amount of emerging-market credit has ballooned in recent years, and it may very well continue to grow as investors pile into the notes. Many of these increasingly extended companies will survive and possibly even put their money to good use, with productive acquisitions or corporate investments. But the risk is that any stretch of disappointments will cause disproportionate pain, foisting outsize problems on companies that otherwise would have solid business models. This will only hamper growth, both at the corporations as well as in the broader economy. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

To contact the author of this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net.