More Companies Bet on Bond Buybacks

Debt repurchases can help companies (and shareholders) by paying off creditors at a discount, but they can signal trouble, too

By Michael Arndt

Back when corporations were swimming in cash, those in the Standard & Poor's 500-stock index spent well over $100 billion every quarter to buy back stock. In this year's first quarter, that total sank to just $30.8 billion, according to a June 18 S&P report, with ExxonMobil (XOM) accounting for a quarter of the outlays. Now some companies are using their piggy banks to repurchase something else: their own debt.

Newspaper publisher McClatchy (MNI), for instance, said on June 18 that creditors that are owed $102.4 million have agreed to swap their notes for cash and new notes paying 15.75% interest. McClatchy's buyback offer follows bond repurchases at such firms as Harrah's Entertainment and Kaiser Permanente.

Investors have often benefited from stock buybacks because they reduce the number of shares outstanding and therefore raise earnings per share. Debt repurchases should have the same effect because they reduce a company's debt-to-capital ratio and delay repayment burdens, which in turn might help the company avert default or bankruptcy, says Vicki Bryan, a senior high-yield analyst with Gimme Credit.

When Sacramento-based McClatchy proposed in May retiring $1.15 billion in junk-rated debt, its share price leaped 30%. Similarly, Las Vegas Sands' (LVS) stock jumped in value in March, when the company said it was looking into buying back part of its debt.

But while shareholders may gain, creditors can't always count on coming out ahead. Companies typically buy back debt at steep discounts—McClatchy is offering only 18¢ to 33¢ on the dollar—which means big losses on investments. Moreover, replacement debt may not come due for years, exposing lenders to further risks. McClatchy's new notes, for example, wouldn't mature until 2014.

Debt Buybacks Can Indicate Problems

On the other hand, a pittance is better than default—and in McClatchy's case, the new securities would pay rates two to three times higher than the retired debt. Creditors often get some up-front cash as a sweetener.

Frequently, too, debt buybacks come as a sign of deep financial trouble. Homebuilder Hovnanian Enterprises (HOV) has become something of a serial debt repurchaser. The money-losing company bought back $578 million in notes earlier this year at discounts that averaged 60%, according to S&P. On June 22, Hovnanian announced a tender offer to buy back a further $88.9 million, including $29 million that comes due in January.

That may be too little too late. Bryan notes that after Hovnanian's latest all-cash repurchase, it still would owe $1.8 billion. She predicts the company will run out of cash before the end of 2010.

At McClatchy, bondholders seem skeptical. Only $3 million of the $170 million in notes due in 2011 have so far been tendered. Rather than accept 33¢ on the dollar, near-term creditors seem to have protected themselves with credit default swaps, which would make them whole even if McClatchy defaults on its obligations, says Jake Newman, an analyst with CreditSights.

McClatchy Treasurer Elaine Lintecum says she cannot comment while the company's offer remains open.

Although the debt deals aren't pitched to them, shareholders have good reason to want them to succeed. Bond buybacks could keep companies afloat, giving their stock some value. And in bankruptcy, equity is almost always wiped out.

Arndt is editor of BusinessWeek's innovation and design coverage, overseeing its Innovation channel as well as the magazine's quarterly IN: Inside Innovation section.

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