- The management team at AT&T has recently engaged in some additional financial engineering aimed at improving the company's long-term prospects.
- This involves extending debt maturities, reducing fixed interest rates, and staggering when payments will be due on debts.
- This move appears wise as the company works to pay down other debt and get itself in a better financial position.
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During these uncertain times, companies that are on shaky ground pose significant risks for investors. But for long-term investors, the high-quality businesses are the exact opposite. Firms like AT&T (NYSE:T) are taking this chance to shore up some areas that are weak and to prepare for the long haul. Case in point, we need only look at the telecommunications and entertainment giant's decision to refinance a significant amount of its debt. At first, it looks like the business will be hit with higher interest expense for some debts as a result, but as interest rates eventually rise, the firm is likely to save millions of dollars every year. In addition, this set of transactions solves the problem of coming maturities that management has elected, for one reason or another, to kick down the road as opposed to pay off as they come due. In all, this is an example of prudent financial engineering that will better position the business for the long haul.
A look at the transactions
AT&T has a significant amount of debt on its books. As of the end of its latest fiscal quarter, the business had $164.27 billion in debt, about $17.07 billion of which was due in the 12 months following the quarterly report's release. Total cash and cash equivalents on hand came out to just $9.96 billion, leaving net debt at $154.31 billion. Earlier this year, the firm's management team forecasted that free cash flow for 2020 should come out to around $28 billion. In its latest press release, the firm seems to have revised this thinking some. It stated that its dividend payout ratio (using free cash flow as the denominator) should be around the low end of the 60% range for the year. If the company's aggregate quarterly payout matches the first quarter's payout, this translates to around $25 billion now. That leaves the firm around $9 billion to $10 billion to put toward debt reduction if it so desires.
Over the past several months, management has been active about coming up with financing options. In November of 2019, for instance, the firm entered into a term loan agreement with tranches of payments staggered for between 2020 and 2022. In April of this year, management entered into a term loan credit agreement with several commercial banks in the amount of $5.5 billion. Despite being issued this year, the maturity of this agreement was set for the end of 2020. Having short-term financing options can go a long way to ensure the stability and flexibility of an enterprise as large as AT&T. However, with the clock now ticking on these agreements, plus some of the firm's Global Notes coming due in the near future ($2.38 billion specified for 2020, $2.75 billion specified for next year, and $1.43 billion way off in 2047), the firm needs to come up with solutions.
To address these concerns, management elected to engage in multiple financing arrangements, with debts staggered over time. The first chunk is the largest. According to the firm's filings, it is issuing Global Notes, with some due in 2027, some in 2031, some in 2041, some in 2051, and others due in 2060. These amounts range between $1.50 billion and $3 billion apiece, with interest rates fixed per issuance (though rates varying per issuance at between 2.30% and 3.85% per annum). The company is not, unfortunately, going to receive full value on these issuances. Discounts of up to 1.23% have been applied, bringing total net proceeds from this $12.50 billion in issuances to $12.395 billion. This works out to extra debt going on AT&T's books of about $105 million.
With these proceeds, management is going to pay down about $12.458 billion worth of Global Notes and term agreements. In all, the firm has selected four different classes of Global Notes. One is for $2.75 billion due this year with an annual interest rate of 2.45%. Two are for 2021 with interest rates of 2.80% for $1.70 billion and 4.60% for $682.7 million. The fourth is for notes due in 2047 with aggregate amounts due of $1.43 billion and an interest rate of 5.50% per annum. In all, this works out to $6.56 billion in debt, with an effective interest rate of 3.43%. Just on this $6.56 billion amount, the effective annual interest savings for the firm will be $17.84 million. But that's not all.
In addition to these notes, management is paying off its full $5.50 billion term loan credit agreement, plus $400 million from the $1.30 billion term loan tranches. These term loan agreements are actually very hard to beat because they incur interest at a variable rate that's the sum of LIBOR plus some percent. The $5.50 billion is at LIBOR plus 1.50%, while the $400 million is at LIBOR plus 0.8%. Due to low interest rates on the market today, the effective interest rate as I type this for these two sets of debt comes out to 2.13% per annum. As interest rates eventually rise, though, this will change. Just about a year ago, in early June of 2019, the weighted-average interest rate on these variable rate debts would have been as high as 3.87%. So while the firm will pay some additional interest on these debts, it will be a blessing to have these fixed rates once interest rates rise again.
As part of this refinancing effort, AT&T is also issuing 3 billion euros' worth of debt, set between three different sets of Global Notes. One is for 1.75 billion euros due in 2028, one is for 0.75 billion due in 2032, and the final 0.50 billion is due in 2038. Interest rates start off at just 1.60% and go up to 2.60%, with the weighted-average interest rate at 1.87%. Put in dollar terms, the 3 billion euros is worth about $3.33 billion. Total discounts on these debts works out to about $19 million. Management did not detail which debts it would be paying off with this issuance, only saying that the proceeds will be used for "general corporate purposes". But with $900 million still due under the short-term term loan agreement, it's safe to assume that it will be a part of that program.
This uncertainty makes it difficult to know the exact cost savings of management's effective $15.8 billion worth of refinancing, but if we assume that savings amount to just 0.5% per annum in the long-run, the company will save $79 million per annum from these moves. At 1%, this doubles to $158 million. Add to that now, instead of having billions of dollars' worth of debt on the horizon, the maturities involved form this series of transactions will mean that amounts will be staggered over a period of many years, with the first chunk, in the amount of $2.50 billion, coming due in 2027, and the last chunk, for $1.50 billion, coming due in 2060. In all, these moves make sense and investors should look forward to other transactions initiated by management over time that will help the firm to improve its bottom line while mitigating interest rate risk and lowering the need to pay out significant cash sums during each of the next few years.
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This article was written by
Daniel is an avid and active professional investor.He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein. Learn more.
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