Heavily indebted companies are going public at the fastest clip in years

April 18, 2013, 8:06 p.m. ET

IPO Investors Conquer Fear of Debt

By TELIS DEMOS And MATT JARZEMSKY

Debt is no longer a four-letter word among investors in initial public offerings.

Heavily indebted companies are going public at the fastest clip in years, as low interest rates ease buyers’ fears about the prospects for stocks whose issuers are burdened with IOUs.Satellite operator Intelsat SA, I +6.94% one of the most highly leveraged companies to come to market since 2009, sold $498 million worth of common and preferred shares on Wednesday. Other recent examples include aquatic theme-park operator SeaWorld Entertainment Inc., which saw strong investor demand and priced at the top of its pre-IPO price range on Thursday, and Pinnacle Foods Inc., PF +0.04%maker of Log Cabin syrup and Vlasic pickles.

Many other leveraged companies are weighing coming to market. Merlin Entertainments Group, the U.K.-based operator of attractions including the London Eye and Legoland theme parks, has said it is considering a public offering and could list in London or New York.

The trend marks another way in which the Federal Reserve’s easy monetary policy is filtering through the financial markets and changing investor behavior.

In more normal interest-rate environments, high levels of debt often are seen as a negative by long-term stock investors because debt payments siphon away cash a company might otherwise use to grow.

Now, many indebted companies are readily getting stock-market funding, in part because debt payments are perceived as less onerous at a time of record low interest rates. In addition, as these companies take advantage of the IPO cash to pay down debts, some are able to offer the kinds of dividend yields that are attractive in an environment with record low interest rates on bonds.

“Coming out of the financial crisis, it was a general perspective amongst buy-siders that leverage was a concern,” said Neil Mitchell, head of financial sponsors’ equity capital markets origination at Credit Suisse Group CSGN.VX -1.83% AG. “But as the economy has improved, and the stock market has appreciated, investors have become more willing to look beyond leverage ratios.”

 

The warm reception for indebted companies can be seen in the growing number of IPOs with high net leverage ratios, a measure of debt relative to annual cash generation.

Seven nonfinancial companies have gone public this year with debt exceeding three times their expected 2012 cash earnings, according to figures from banks and analysts. The figures are limited to companies raised at least $250 million at their IPOs and have an overall value of $1 billion or more. There were six such listings last year and 14 from 2009 to 2011.

Companies in the Standard & Poor’s 500-stock index have average debt of 1.2 times expected cash earnings, according to FactSet.

“Low rates, extended maturities and a positive macroeconomic backdrop have enabled companies with meaningful leverage to successfully execute IPOs,” said Michael Cippoletti, head of U.S. equity capital markets at BMO Capital Markets Corp.

Sandy Rufenacht, the chief investment officer at Castle Rock, Colo. stock and high-yield bond manager Three Peaks Capital Management, says he has been seeing more IPOs with debt that look attractive. Three Peaks bought shares in the IPO last month of Pinnacle Foods, which has a post-IPO leverage ratio of 4.7, according to BMO. “The management teams of companies are able to extend maturities [and] not pay much in the way of a coupon,” he said. “Thank you, Fed.”

In all of these deals, the companies have said that proceeds will be used to pay down debts, and won’t go to their private-equity owners. But in some of these cases, the companies also have stated their intent to pay dividends to investors.

On Thursday, SeaWorld, which is backed by Blackstone, priced its IPO, which raised $702 million. It struck an agreement in early April with some of its lenders that ensured that it could pay a quarterly dividend to public shareholders.

SeaWorld intends to pay a dividend that would give shareholders roughly a 3% annual yield. That compares with a 2.2% yield on stocks in the S&P 500.

That followed Wednesday’s IPO of Intelsat, which raised $472 million for the company after underwriter discounts and fees.

Intelsat has a leverage ratio of 7.6, according to Renaissance Capital LLCan IPO research firm. Realogy Holdings Corp., RLGY +0.24% a real-estate brokerage company that went public in October, is the only other company that had a ratio of more than 7. Intelsat has been in the hands of private-equity firms since 2005.

In 2011, as interest rates tumbled, Intelsat began refinancing billions of dollars of debt as a way to cut interest costs.

The performance of these IPOS has been mixed after coming to market. Realogy, which sold shares at the top of its pre-IPO price range, is up 71% from its October debut, having ridden a wave of enthusiasm for the housing market.

Berry Plastics Group Inc., BERY -1.56% a maker of plastic containers for consumer goods, which debuted at the bottom of its projected range, is up just 6.4% from its IPO pricing.

Intelsat shares rose $1.25, or 6.9%, to $19.25 on the New York Stock Exchange.