A Great Time To Borrow a Few Billion

Ever have that sinking feeling that you’re not saving enough for retirement? Well, if there are any banks out there prepared to lend you a few billion dollars you might want to consider going deeper into debt and buying a medium-sized, publicly traded corporation. That’s the moral of the Matthew Klein chart posted above.

The blue line is the “earnings yield” of the S&P 500 as a whole. A company’s earnings yield is its profits divided by the price of all its market capitalization. Think of it as the return you would earn if you bought up all the stock in the company. The red line is the prevailing interest rate on risky “junk” bonds. We are today in a very unusual situation, where the junk bond yield is lower than the yield on the average publicly traded company. That suggests that good leveraged buyout opportunities are all over the place, and you wouldn’t necessarily even need any genius turnaround plans to make them profitable. Now probably no bank is going to lend you the billions you would need (sucks for you) but that’s great news for private equity players who have what it takes to put a deal together. Hence Klein’s forecast that Dell is likely to be just the beginning and “we may see more big leveraged buy-outs if this unusual spread persists.”

The chart, however, very nicely illustrates what I think is one of the big mysteries of corporate finance. Why don’t more public firms do the leveraging for themselves? Why wait for the buyout?

After all, the most simplistic LBO strategy—load a company up with debt to render its capital structure more tax efficient—should be available to just about anyone. You’d think this would be particularly attractive since a Microsoft, say, can borrow money at a considerable discount to the junk rate. Don’t get me wrong, it’s probably good for the world that healthy non-financial firms don’t go around borrowing tons of money to finance huge stock buybacks. But executives do things that are bad for the world all the time.