Low-yield bonds are now helping many companies add to their cash hoards. That's good news for investors … but not necessarily for everyone else.
Among the companies stuffing their piggy banks:
- McDonald's (NYSE: MCD) recently raised $750 million by selling bonds, and was able to set an ultra-low interest rate of 3.5% on its 10-year debt. In contrast, Linn Energy (Nasdaq: LINE) recently sold $1.3 billion worth of 10-year bonds at a rate of 8.625%.
- Oracle (Nasdaq: ORCL) has raised $3.25 billion via bonds this year, including $1 billion in 10-year debt with a rate of 3.875%, and $2.25 billion in 30-year bonds with a rate of 5.375%. These top Treasury alternatives by 0.85 and 1.4 percentage points, respectively.
- Microsoft (Nasdaq: MSFT) grabbed $3.75 billion via its first bond offering last year, then followed up with more, including $1.1 billion raised this year through interest-free convertible bonds.
- IBM (NYSE: IBM) just sold $1.5 billion in three-year debt with an interest rate of just 1%.
What's going on here?
The demand for such bonds is driven partly by investors weary of the puny interest rates they're getting from banks and government bonds. McDonald's 3.5% rate may not be exciting, but it beats many other fixed-income options, while still seeming rather safe.
The environment isn't always this good for corporate bonds. When overall interest rates are high, corporate bonds also command high rates, making many companies prefer to raise money by issuing more stock. Though adding to their share count dilutes the value of existing shares, many companies prefer that option. Annaly Capital Management (NYSE: NLY), a robust dividend payer, recently announced that it would sell 60 million more shares, in order to raise about $1.1 billion for new purchases.
Smart corporate asset management means that the cost of raising money adds up to less than the returns you make on the money you've raised. The lower their interest rates, the more compelling an option debt becomes for a company.
Benefits and downsides
Companies now selling bonds are raising cash for many reasons. Some may simply want to build up cash reserves, in case the economy turns sour again.
Oracle is using some of what it raises to pay off other debt, and possibly to fund acquisitions. It raised $4.5 billion via debt last year to aid its $7.3 billion purchase of Sun Microsystems.
Microsoft has plans to spend as much as $40 billion buying back its own stock -- a smart move when shares are undervalued. Reducing the number of shares on the market increases the value of the stakes shareholders already own.
Drawing upon too much debt, however, can ensnare a company in interest payments. If cash flow sputters, the company many not be able to keep up on what it owes. Altria (NYSE: MO) recently sold $200 million in additional debt, even though it already sports more than $11 billion in long-term debt on its balance sheet. In comparison, it records only $3 billion in cash and cash equivalents. Many investors trust Altra's relatively stable operations, but its huge debt has prompted others to steer clear.
Big debt sales are often great for companies and their investors, but they can hurt other areas of the economy. If companies spent their cash instead of stockpiling it, they could give the economy a much-needed shot in the arm. Many companies laid off gobs of workers in the past few years; still stinging from the recent recession, businesses now seem more focused on strengthening their financial positions than rehiring their former workers.
Eventually, companies will spend most of the cash they're now raising, speeding our recovering and renewing job growth. Until then, investors seeking outstanding companies should keep an eye on how companies are managing their balance sheet. A growing cash pile can give a company more flexibility to pounce on lucrative opportunities. Grabbing that cash by issuing debt when interest rates are low seems like a smart way to do so.
