Depressed prices in the junk-bond market seemed to foretell an unprecedented Armageddon of bankruptcy as record numbers of firms defaulted on their debt. Gloom was the order of the day.
Twelve months later the mood in many boardrooms has been transformed. Fear and trepidation have given way to cautious optimism. Admittedly, this is mostly a reflection of the improvements firms have made to their own operations, and of the remarkable revival of the capital markets, rather than any firm signs of a return to strong growth in the rich world. But, while the chill wind of recession may continue to whistle through the streets, there will be a cosy warmth up in the executive suites as bosses contemplate the opportunities that the improving outlook, and their strengthening finances, will bring.
Since the crisis began, firms have sharply increased their holdings of cash—up by a combined $290 billion in America, Europe and Asia compared with 2007, according to Citigroup. Low interest rates in the reopened capital markets have led to astonishing amounts of debt issuance, particularly in the junk-bond market. This has reduced the fears of firms needing to refinance existing debt, which could have faced bankruptcy had the credit crunch continued a while longer. Although in the fourth quarter of 2009 the 12-month default rate on high-yield bonds rose sharply to 12.5% worldwide (and 13.2% in America), from 4.2% a year earlier, that was lower than many experts had predicted. According to Moody’s, a ratings agency, the default rate is now edging down and is on course to fall sharply.
In a new report, “2010 Corporate Finance Priorities”, Carsten Stendevad and colleagues in the Financial Strategy Group of Citigroup argue that this improvement in financial health will produce a sharp increase in both capital spending and mergers and acquisitions, as firms try to restart their growth engines. Kraft’s agreed £11.9 billion ($19.7 billion) bid for Cadbury, thrashed out in the early hours of January 19th may therefore mark the start of a trend. The Citigroup team forecast a 17% increase in worldwide merger activity by value in 2010, with the biggest spenders of all being Asian firms, many of which are highly liquid. Almost half of the Asian firms in the MSCI Global Index have higher cash balances now than at any time in the past five years.
There is also likely to be a further increase in initial public offerings, following the reopening of the market for these last summer. The Citigroup report expects a new trend of multinational firms listing shares in their emerging-market operations as separate entities on the Hong Kong Stock Exchange, where they are likely to attract a higher valuation than elsewhere. Whether this turns out any better for investors than the “tracking stock” phenomenon seen during the dotcom bubble (in which firms issued equity whose value notionally tracked that of their supposedly high-growth, technology-related divisions) remains to be seen.
Bank credit may remain scarce so companies short of cash to finance their expansion will have to rely on the debt markets, and hope they do not freeze up again. Firms that do have cash are unlikely to be allowed to sit on it by their investors. If there are not good acquisitions to make or organic-growth opportunities to invest in—and perhaps even if there are—shareholders are likely to urge firms to hand them some cash by reopening the share-buyback programmes that were abruptly halted when the crisis struck.
What might keep company bosses, and chief financial officers, awake at night this year? According to the Citigroup report, the potential bogeyman is the government. Taxes seem quite likely to rise, with a possible reversal in the trend of falling corporate-tax rates and perhaps also reductions in the various tax exemptions that have proliferated over the years. The report argues that foreign profits are likely to face particular scrutiny from the United States Treasury, which may encourage a growing number of American firms to relocate to more tax-friendly domiciles. Then there is the tricky matter of governments starting to withdraw their support from the financial system, and how that will affect the recent capital-market revival. There is no road-map for governments to do this, so firms should prepare for a bumpy ride.
Indeed, it could be worse than bumpy. Economies reliant on government stimulus that cannot last forever may relapse into a double-dip recession. Thus, while company bosses are justifiably far more optimistic than a year ago, they are, equally justifiably, cautious in their optimism.
By: N. Peter Kramer
