New York: AT&T is reportedly on the verge of announcing yet another massive merger, this time with $71 billion Time Warner. The goal here sort of makes sense: AT&T has the distribution network and it wants the content of Time Warner, parent of HBO, CNN and TBS.
But should AT&T follow through with a Time Warner purchase, its debt may balloon to levels that would put it at risk of a downgrade. That’s a significant concern for both AT&T, the second-largest US wireless carrier, and the broader $8 trillion corporate-bond market, considering that this company already has more than $120 billion of debt outstanding.
Let’s put that debt load into context. It’s more than any other non-financial issuer in the US corporate bond market and more than four times as much as the biggest US junk-bond seller.
At a minimum, any downgrade would dent the value of AT&T’s debt and send its borrowing costs higher. So what would it take for that to happen? Its current rating is BBB+ at S&P, three levels above junk, after being cut in 2015 in the wake of its $18.2 billion purchase of AWS-3 wireless spectrum licenses. AT&T has said it wants to reduce debt to regain its higher rating, but this deal very well could move it in the opposite direction.
Let’s say it were to pay all cash for the transaction and a 20% premium to Time Warner’s current market value, which has already risen amid the takeover speculation. AT&T would have to borrow billions of dollars in additional debt because it currently only has $7.2 billion of cash on its books. Net debt would then potentially surge to more than three times the combined Ebitda that AT&T and Time Warner are forecast to generate next year. That would be enough for a downgrade, according to a recent S&P Global Ratings report.
AT&T is already nearing its leverage limits for its current rating at Moody’s, so a material increase in debt over Ebitda will put it at risk for a downgrade at that credit-rating company.
This is all hypothetical, of course, and if recent reports are correct that an agreement could be reached as soon as this weekend, we’ll learn the actual deal terms soon enough. Bloomberg reported late Friday that AT&T is talking about buying Time Warner for about $110 a share, in a deal structured as half stock, half cash. While that wouldn’t boost AT&T’s overall leverage ratio as much as if the carrier used all cash, it will still probably require its incurring more debt. That means the combined company needs to demonstrate it’s even more profitable than the two separate corporations or else face higher debt-to-income ratios, and a possible downgrade. The potential for this type of disruptive development happening matters greatly at a time when investors are pouring near-record amounts of cash into the US credit market. Just last year, a Moody’s downgrade of Sprint, the biggest US junk-bond issuer, sparked a tumble in that wireless carrier’s debt and sent jitters through the high-yield market, showing how unsettling it can be when a dominant corporate-bond seller’s rating is cut.
And in Sprint’s case it was already junk-rated. Were AT&T to lose its investment-grade status, that could trigger more disruption as some bondholders can’t hold high-yield debt and would be forced to sell. AT&T still has a fairly long way to fall before it loses its high-grade status, but a massive deal like this needs to be monitored closely by credit investors to make sure that it’s creating more value than it’s destroying.
Investment-grade corporate bonds are poised for their best annual performance since 2009. Going forward, it’s idiosyncratic events like this that may drive whether the investments remain winners or turn into losers. Bloomberg