Lowered Debt Doesn’t Spur Investing

Caution Persists as Economy Begins to Stir

By KATE BERRY

Staff Reporter

Like homeowners who have refinanced their mortgages over the past year or two, L.A.’s largest public companies have been restructuring their debt burdens to take advantage of lower interest rates.

It’s been a boon to the companies, helping them improve profitability and cash flows at a time when the business environment isn’t well suited for growth.

But unlike consumers, who have used that extra cash to buy new cars or washing machines to keep the economy going, businesses have been stingier.

Instead, they’re buying back shares or increasing dividends actions that don’t bode well for growth. Some experts believe the reluctance to invest at a time when interest payments are falling as much as 30 percent or 40 percent at many companies is a bad sign for the economy.

According to an examination of corporate debt by Duff & Phelps LLC, L.A.’s 20 largest public companies saved a total of $129.3 million

in lower interest payments in the second quarter of 2003, compared with the like year-ago period.

Lower interest rates have multiplied the impact of lower debt loads, which have come down the past two years.

The total debt carried by the 20 largest publicly traded companies in Los Angeles (measured by market capitalization) fell by 0.2 percent from June 2002 to June 2003, to $65.67 billion, according to Duff & Phelps.

Being frugal isn’t necessarily a bad thing, at least after gorging on debt like many companies did in the late 1990s. Corporate borrowings hit a peak in 2001 at $458.7 billion, according to a recent report by Lehman Brothers.

But in the past two years, the amount of new debt issued by U.S. companies in the form of investment grade corporate bonds has plummeted to just $147.6 billion, the lowest level in five years.

“It’s certainly healthy for a lot of these companies to get themselves in a position where they’re not overleveraged,” said Michael Fishman, executive vice president at Wells Fargo Foothill, which lends to mid-size companies. “But if they want to grow again they will have to start spending money on capital expenditures.”

Some companies have put their cash to work instead by repurchasing stock at relatively high prices rather than paying down debt.

Joseph Marinucci, a fixed income analyst at Standard & Poor’s, has been critical of Health Net Inc., the Woodland Hills-based holding company for managed care provider Health Net of California.

Marinucci has suggested that the company cut back on the dividend payments that its operating units, which are not well capitalized, make to the unregulated parent company.

Despite a decrease in overall debt load to $398.9 million in the June quarter from $518.8 million one year earlier Health Net has a credit rating that is one notch above junk bond status. An equity infusion to the firm’s operating units would go far toward a higher rating, Marinucci contends. Instead, Health Net’s board authorized a $200 million stock buyback program.

David Olson, senior vice president of investor relations, said “the balance sheet is stronger than it’s been in a long time because we’ve paid off debt over the last several years.” He pointed out that S & P; has improved its outlook on Health Net’s debt as a result.

Others that have pared down debt in the past year include Mattel Inc., down 34.8 percent, Public Storage Inc. (12.6 percent) and Jacobs Engineering Group (70.8 percent).

Last week, Hilton Hotels Corp. secured a revolving credit agreement that it said it would use to pay back some of its long term debt.

Two companies that have bucked the trend are defense contractor Northrop Grumman Corp. and satellite firm Hughes Electronics Corp., a unit of General Motors Corp.

Northrop, based in Los Angeles, has been encouraged to expand by fattening government spending on defense. It also ratcheted up borrowings and issued 184 million shares of stock to fund its purchase of TRW Inc. last year.

Hughes’ DirectTV Holdings LLC unit raised nearly $3 billion in new debt this year, using some of the proceeds to repay older debt and some to fund its business.

“We raised some extra debt because the markets are so good and we felt like striking while the market was hot,” said Martin Sheehan, a senior manager in investor relations for Hughes.

Public Storage had a 70 percent drop in interest payments in the past year to $400,000 in the second quarter, down from $1.2 million. The Glendale company plans a $6 million stock repurchase plan, but its outlook has been cautious, as renters became homebuyers in the past couple of years and lessened their demand for storage rentals.

Bankers, too, have had to change their attitudes. Over the past few years, many have urged companies to cut their bloated debt levels to shore up their balance sheets.

But commercial banks are now worried because as companies pay off existing debt, it becomes more difficult to replace the volume of loans, particularly in a low interest rate environment. As overall borrowings drop, it puts pressure on lenders that want to grow their portfolios.

“You could also read the tea leaves as indicative that companies are more cautious about floating debt and are deferring acquisitions and capital expenditures because they’re not confident about a recovery,” said Nehama Jacobs, treasurer of the Los Angeles chapter of the Association for Corporate Growth.