Dell Technologies ’ spinoff of VMware should leave it with better credit. And it isn’t the only large company that will see its balance sheet improve this year, Bank of America says.
This week, VMware (ticker: VMW) sold $6 billion of bonds to pay for a dividend as part of its spinoff from Dell (DELL) that was announced in April. And while VMware’s investment-grade rating helped keep its borrowing costs low in Tuesday’s bond sale—it sold a $1.5 billion tranche of 10-year bonds at a yield of 2.2%—Dell is still rated at junk. It has the equivalent of a BB+ rating from S&P Ratings and Moody’s, one tier below investment grade.
That could change soon. Dell is slated to get up to $12 billion as a cash dividend as part of the spinoff, and said in its first-quarter earnings call that it would pay down $16 billion of debt in fiscal 2022. “Our expectation is that once the spin of VMware is finalized, we will be upgraded to investment grade by all three credit rating agencies,” said Dell CFO Thomas Sweet on the call.
A lot of the time, the potential reward to shareholders for these types of “rising star” upgrades isn’t obvious. After all, when a company uses cash to pay down debt, that means there is less cash available to return to shareholders.
But as Bank of America points out, the Federal Reserve’s response to the Covid-19 pandemic created a reason for shareholders to cheer a company’s investment-grade status: the possibility of access to cheap backstop financing in a crisis.
In the early days of the pandemic, when markets were freezing up and companies were racing to secure cash, the central bank opened facilities to buy investment-grade bonds. And while it did buy some high-yield ETFs, it reserved most of its purchasing power for companies that were rated investment grade before the pandemic hit.
“The Fed’s bailout last year of [investment-grade credit] means large [high-yield] issuers will aim to get upgraded so they too can potentially get bailed out in the next crisis,” wrote strategists at Bank of America in a July 20 note.
For those who assume the Fed will use the same set of tools in future downturns, that would mean investment-grade companies may have a better chance of survival in the next crash, even if those companies’ balance sheets are directly affected by whatever misfortune strikes and they get downgraded to junk as a result.
Bank of America’s strategists believe that will encourage companies to improve their balance sheets and credit ratings and look for investment-grade ratings. They argue that Dell serves as one example. In fact, the tech company’s secured bonds, or those that have collateral attached, are already rated investment grade.
So they looked for other companies that could be upgraded, and used a couple of different metrics that stood out as especially interesting: Junk-rated firms that are already selling bonds with investment-grade ratings because those bonds are tied to some valuable collateral, and companies that are large borrowers and have the greatest incentive to get an upgrade.
Other than Dell, the junk-rated borrowers selling investment-grade secured bonds include:
- Charter Communications (CHTR)
- T-Mobile US (TMUS)
- HCA Healthcare (HCA)
- United Rentals (URI)
- NRG Energy (NRG)
- Vistra Corp (VST)
- CF Industries Holdings (CF)
- Graphic Packaging Holding (GPK)
- Microchip Technology (MCHP)
- Silgan Holdings (SLGN)
And the largest junk-rated borrowers include:
- Ford Motor Co. (F)
- Occidental Petroleum (OXY)
- Charter Communications
- Kraft-Heinz TK (KHC)
- Centene Corp (CNC)
- T-Mobile US
- HCA Healthcare
- FirstEnergy (FE)
- Sirius XM Holdings (SIRI)
Of course, the U.S. economy has rebounded quickly from the pandemic slowdown and the Fed probably won’t need to intervene in markets soon. But if it eventually does, and these companies take advantage of the expansion to shore up their balance sheets, they could find themselves in a position to get emergency financing if they need it and stock investors can enjoy the upside of improved fundamentals.
Write to Alexandra Scaggs at [email protected]
