Only the Strong Shall Thrive

Financially sound companies find gold in credit mayhem even as weaker players fear the game is up.

Renegotiation may have its limits in this market. “We expect Standard Pacific will violate its tangible net worth covenant (it must stay above $1.37 billion) in the second half of 2007,” wrote Banc of America Securities analyst Daniel Oppenheim. “We believe lenders remain flexible on renegotiating covenants for now, but see risk as conditions deteriorate further.” Smelling opportunity, hedge fund Citadel LP acquired a 4.9 percent stake in Standard Pacific in August.

Not everyone is convinced the roof is about to cave in. Brian Ranson, managing director of credit strategies at Moody’s K.M.V., which tracks corporate default risk, says that aside from the real estate sector, many companies remain in good shape. “We measure the default risk of tens of thousands of companies,” he said in late August. “What we observe is that the strength of Corporate America is not affected by subprime [issues].”

Cash Is King — Again

Indeed, while credit costs are rising and leverage ratios are tightening for speculative-grade issuers, other companies are in pristine condition. “We spent the past few years preparing ourselves for just this type of market,” says David Johnson, CFO of The Hartford Financial Group. “The time you want to have liquidity and capital is when other people don’t.” The Hartford has increased its credit facility to $2 billion from $1.6 billion and extended its maturity. Luckily, it began negotiating with its banks in the spring and managed to close the amended facility on August 9.

To build another layer of protection, The Hartford also entered into a funded $500 million contingent capital facility that can be tapped “on a rainy day” in the future. While he would like to believe his firm could get the same terms even in the middle of the credit crisis, Johnson is not certain.

Like The Hartford, many companies have been accumulating cash. A survey last May by the Association for Financial Professionals found that 36 percent of companies responding held more cash and short-term equivalents than 6 months earlier. (Eighteen percent decreased balances; the rest saw no change.) Moreover, 27 percent expected to add to their cash balances in the ensuing 12 months. Most stashed funds in money-market funds, bank deposits, and commercial paper.

What is The Hartford doing with its excess cash? Johnson says current conditions may well present a stock-buyback opportunity. The firm’s share price was only 5 percent above its 52-week low in early September. It has a $2 billion authorization, of which it has already purchased $250 million worth of shares. Indeed, S&P 500 companies spent a record $158 billion in the second quarter on stock buybacks, the seventh consecutive quarter of more than $100 billion in such spending.

Companies have been hoarding those repurchased shares in Treasuries without retiring them, says Howard Silverblatt, senior index analyst at Standard & Poor’s. One way to use them, he says, would be for acquisitions.

For strategic buyers, this is a good time to shop. M&A volumes are already down from the record $2.65 trillion of the first half of 2007 and premiums are lower. In the days of extreme liquidity, private-equity buyers drove up prices, often snatching deals from strategic buyers. “Private-equity buyers were able to raise their bids because they were able to borrow so much — seven times cash flow plus 25 percent in equity,” says Steve Bernard, director of M&A market analysis at R.W. Baird & Co. “It has probably come down to four or five times cash flow.”

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