The Dolan family’s decision this week to drop its plan for a leveraged buyout of Cablevision but to push instead for a $3bn special dividend earned a mixed reception from the bond market.
Bondholders were relieved to see the back of potentially massive additional leverage and the associated threat of multiple credit rating downgrades for the cable operator. But, on the other hand, they realised the company would still need to raise additional debt – albeit less than for an LBO – to pay the proposed dividend.
Cablevision would still risk a downgrade if it borrowed money to pay the special dividend, according to Matthew Wilcox, an analyst at high yield research firm KDP Advisors.
The Dolans’ methods may sometimes be unorthodox, but bondholder anxiety about “shareholder-friendly” activities, whether LBOs driven from outside companies or increased leverage from within, is not limited to Cablevision. It is a broad theme for bond investors in today’s market conditions.
The Dolans summed up their assessment of the situation in their press release: “The credit markets currently value the company’s growing cash flow to a greater extent than the equity markets.”
“The Dolans apparently intend to test their hypothesis and arbitrage the equity and debt markets by paying shareholders [including themselves] by raising debt,” says Jake Newman, an analyst at CreditSights.
“If the debt markets place a higher valuation on a set of assets, the leverage that can be placed on the assets is commensurately higher.”
In Cablevision’s case, the Dolans also stand a better chance of getting their way working from inside the company. They said they were unable to reach agreement with the directors negotiating the LBO on behalf of the other shareholders. But assuming they are allowed to vote on a special dividend, they could carry the day with their 71 per cent of shareholder voting rights – despite owning only 20 per cent of Cablevision.
That lesson too could apply more widely. Companies unable to agree to LBOs, or keen to avoid being targeted, can decide to increase leverage by themselves – rewarding shareholders with cash payouts at the expense of bondholders.
Other factors may also have influenced the Dolans’ switch in strategy. Cable valuations have generally declined since the LBO was tabled in June. Mr Wilcox of KDP notes that the junk bond market has taken on a relatively sober character in recent weeks.
Cablevision may face difficulties even financing a $3bn special dividend in the high yield market, according to Mr Wilcox.
“We are not convinced that the company will obtain the necessary financing . . . considering the current cautious tone,” he says.
The bank and institutional loan market, however, remains an alternative and it may be more receptive to Cablevision debt than the junk bond market, Mr Wilcox says.
Retailer Neiman Marcus found this to be the case when it shifted part of its recent LBO financing package from the bond market to the loan market.
In any event, bondholders worried about increasing corporate leverage cannot rest easy just yet.
“While conditions have been more favourable for issuers at other times during the year, it is not a bad market fundamentally,” says Martin Fridson, publisher of the Leverage World research periodical.
High yield mutual funds have seen outflows for the last six weeks, according to AMG Data, taking the pressure off institutions to put money to work.
“In this environment the same investors will say there were problems when they wouldn’t have said that before,” he says.
LBOs are particularly sensitive to market conditions, according to Mr Fridson.
“If you do an LBO today, you’re not going to come [to the market] for the permanent financing for a few months. The market has been so changeable this year [that] it’s hard to say what financial conditions will look like three months down the road.”
He notes, for example, that the bond financing for the LBO of SunGard Data Systems this year was, in the end, larger than had been originally planned.
The Dolans may not, however, be home and dry with their dividend proposal, because their existing creditors may be able to prevent the extra borrowing that would be required.
“We believe [Cablevision] will need to go back to its panel of banks to renegotiate its $2.4bn credit facilities,” says Mr Newman of CreditSights.
“The current facility expires in June 2006 and has covenants that would prevent issuance of enough debt to pay the special dividend the Dolans propose.”