WeWork, Uber and Tesla are banking on their brand name
appeal to pile on junk debt typically deemed too risky for
lesser known peers with better credit.
Investors are eager to lend to them, favoring
companies’ potential over their underlying financial health,
because those chasing yield haven’t had a lot of choice
“In general, unicorns don’t belong in high yield,” says
one fund manager.
Some of the biggest darlings of the tech industry have joined
Tesla recently in piling on cheap debt to fuel booming growth
plans, relying on their size and brand-name appeal to secure
funding typically deemed too risky for lesser-known peers with
WeWork, rated B, (otherwise known as junk) issued a $702 million
bond in April. Uber issued a $2 billion junk bond deal last
month, despite rapid cash burn and growing competition. And while
Tesla’s precarious debt situation is nothing new, it’s in a
similar boat to the others. Tesla is giving some investors
jitters because it has $1.6 billion of maturities looming over
the next 12 months.
Investors are favoring companies’ potential over their underlying
financial health, in part because they’re benefitting from the
“halo effect” of their sexy, big-name brands, says Christian
Hoffmann, a portfolio manager at Thornburg Investment Management.
It’s a marked shift in the industry. Demand is growing, for
now. But it’s a risky scenario.
Unicorns don’t belong
“In general, unicorns don’t belong in high yield,” said John
McClain, a portfolio manager at Diamond Hill, a US investment
firm that manages fixed-income funds. “Putting financial leverage
on companies with high levels of operating leverage, minimal
tangible assets, and/or the ability to generate cash flow is
Leverage refers to the amount of debt a company has amassed over
its earnings. Having high leverage means a company has more debt
than assets available to pay off debts at a given time.
On the whole, investors tend to steer clear of companies that are
highly leveraged or have far from robust credit metrics, says
Christian Hoffmann, a portfolio manager at Thornburg Investment
Take WeWork: The company received $4.4 billion in investment from
a major SoftBank fund last year but runs an “asset light” model
because it leases most of its office space. Despite plenty of
hype, the company posts loss after loss, and according to
Moody’s, is unlikely to turn a profit anytime soon.
In August, Moody’s took the unusual step of withdrawing a B3
rating on the New York-based company, citing a lack of
information. For bond holders, the company’s limited assets make
it a riskier proposition in repayment terms if things go south.
Chasing yield is getting tougher
Tesla’s high leverage and cash burning activities have given some
investors cause for concern because the company will eventually
need some way of paying it off, and it’s not clear it will be
that easy. The company took its first foray into the junk bond
market in August 2017 with a $1.8 billion issue.
WeWork declined to comment for this story. Uber and Tesla didn’t
respond to requests for comment.
Bond investors chasing yield haven’t had a lot of choice lately.
But they have found a home in this part of the market. With high
return comes more risk, though. A set of poor earnings could lead
to declining confidence from lenders and greater scrutiny of the
market. Throw in a US recession, and things could get very, very
These companies and other unicorns tend to be “highly reliant on
capital markets and have very pressing debt issues,” McClain
And then there’s Uber’s. Its $2 billion bond deal last month was
compared to deals by WeWork and Tesla, because of the company’s
rapid cash burn as competition heats up with rival ride hailer
Lyft. Uber lost an eye-watering $4.5 billion in 2017. The company
was able to issue its bonds via a private placement, allowing it
to bypass the Securities and Exchange Commission’s reporting
So-called “leveraged loans” have garnered a lot of negative
attention lately, with former Federal Reserve Chair Janet Yellen
and the Bank of England among those
sounding the alarm on their potential risk. But the $1.6
trillion market is hot nonetheless: Responding to strong demand,
Uber also raised a $1.5 billion leveraged loan directly from
investors in March, a higher amount than the company had
Leveraged loans differ from high-yield bonds in that they are
secured, meaning creditors are paid before bondholders. Volumes
have spiked in recent years with covenants protecting lenders
from defaults deteriorating over this period, making the loans
more akin to bonds.
McClain said that the high-yield market has been lucrative to
tech stocks because financing has tended to be cheaper and more
effective than selling more stock.
The message is clear: If you’re a big-name tech company with even
bigger ambitions, investors are lining up to lend to you.
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