Navigating Flexibility in Corporate Credit Markets

With the rise of technology, media and telecom credit markets, our analyst explains how companies are looking to manage the rapidly changing landscape. 

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. 

David Hamburger: And I'm David Hamburger, Head of U.S. Sector Corporate Credit Research and Lead Analyst for High Yield TMT here at Morgan Stanley. 

Andrew Sheets: And on today's special episode, the podcast, Dave and I will be discussing corporate credit analysis, the TMT sector and what may be ahead for credit investors. 

Andrew Sheets: David, I think it's safe to say that a lot of listeners are going to be a lot more familiar with what an equity analyst does. So before we get into your sector, I think it'd be great to just take a step back and how do you think about the role of a credit analyst, and how does your job differ from your equity analyst colleagues that sit across on the other side of the floor? 

David Hamburger: So, you know, we're primarily focused on the other side of the balance sheet compared to the equity analyst. So we'll be looking at the liabilities that companies have. Those liabilities do trade in the market and people invest in bonds, loans and otherwise. And importantly, the thing that we really do focus on the most is a company's willingness and ability to service debt and repay that debt. We are certainly concerned with how companies generate shareholder value. But importantly, it's really, really crucial and critical to understand a company's ability again and willingness to repay the debt that's on the balance sheet and the liability part of the balance sheet in particular. 

Andrew Sheets: We're also coming into 2024 at a pretty interesting time for corporate credit markets. You know, you've had yields on some of these high yield bond issuers or loan issuers, a double from where they were in 2021/2022. So you have a market that is offering higher yields than in the past, but also with quite a bit of volatility dispersion between better and weaker balance sheets, and quite a bit that's going on, that's getting investors attention. 

David Hamburger: Yeah. There are a lot of opportunities in corporate credit in general. And you know, people sometimes lose sight of the fact that there's quite a diversity of investment opportunities, whether you're looking at many different sectors in energy, consumer retail or importantly, the TMT sector that we look at, and you can really find situations that suit your risk profile and how much risk appetite an investor might have. 

Andrew Sheets: So let's dive a bit into that sector and how you're thinking about it. And again, there might be some investors that are very familiar with the idea of TMT credit and TMT standing for technology, media and telecom. What has been the story in TMT credit over the last five years? What has brought the sector to its current position? 

David Hamburger: I would say the thing that people have really focused on are some of the technological changes that emerged from the Covid pandemic. If you consider and you look at, you know, where we'll focus a lot of our attention on the telecom and cable sectors. And you look at what transpired during the pandemic. You really had two trends that were overarching. The first was connectivity. I mean, everyone was homebound in a situation where, you know, we were not going into work, going to our normal social interactions that we normally had. And connectivity was paramount. The second thing that it that helped spur huge technological advances, I think during that period of time, you probably saw what the types of technological advances that might have taken a cycle of a couple of years in just a few months, strikingly. And so what had transpired then is really we're seeing the fallout of some of those trends where you saw a number of consumers look at the opportunity to better connect through wireless, through broadband services, new technologies that those companies needed to embrace in order to reach the consumer and reach those new subscribers. And it's really been a trend that, you know, we continue to follow. And has really probably been that had the largest impact on this sector overall. 

Andrew Sheets: I think it's safe to say that consumers access to more media now than they've ever had before, which is a nice thing. But how do you think about the opportunities and the challenges that's created for companies, and how companies are dealing with that just seismic and rapid shift in the landscape. 

David Hamburger: So companies need to be extremely nimble. Management teams need a vision and have a lot of foresight how those technologies will evolve. For many of these companies and for this industry in general, that tend to be very high barriers to entry. Why is that? They're extremely capital intensive. So if you look at like a cable company or a telecom company, even a lot of the big media companies spend an incredible amount of money on their networks, on service, on content production and otherwise. And so importantly, what has ultimately been one of the most defining aspects of this period of time has been companies that are nimble, but really that have financial flexibility. When rates were very low and we had very accommodating credit markets, that helped facilitate a lot of that investment that companies needed. But now when we saw the rising rate environment, it really impacted the fact that a lot of these companies had elevated leverage, that needed it in order to undertake these intensive capital programs. So I would say what really has defined the trend in the space, is those companies with strong balance sheets, financial flexibility, management teams that have remained nimble, have succeeded and thrive in this environment. But on the contrary, companies that were extremely elevated amount of leverage on the balance sheet, found themselves with less financial flexibility to perform and compete. And we're really seeing the fallout from that trend over the last two years. 

Andrew Sheets: So, David, I think you've set that up really well. And so, I guess, as you think about the importance of flexibility, and you kind of highlighted the advantages of being more nimble and being more flexible. Do you think this is going to be a story where the market has already rewarded those better, more nimble companies? Or is this a theme that still has further to play out as the market does further differentiation between the two? 

David Hamburger: Yeah, it certainly has more room to run here in terms of differentiation. A lot of it is really around those new technologies. You begin to see this technological advances around more bandwidth and better networks and upgrades. And so, you know, that creates more competition. But at the same time, as we've seen the acceleration of the adoption of more connectivity, it becomes a more mature market. And so those competitive risks get exacerbated by some of the things like market maturation and even saturation. And as well, you can't minimize things like government subsidies that helped Americans stay connected. And so that dynamic continues to create a tension in the sector in terms of the haves and the have nots and the ability to better compete, the financial wherewithal to compete, and management teams that are very adept and nimble at, you know, embracing those new opportunities. And I think ultimately, what you will see is you're going to see further rationalization of the sector as a result of this, where you'll begin to see and particularly if rates start to come down, one of those follow throughs, or one of the potential outcomes of that is really a potential for more M&A in the space. 

Andrew Sheets: So, David, we started this conversation acknowledging that a credit investor and an equity investor might be looking at the same company, but approach that from a different point of view and different areas of emphasis. And I guess to conclude this conversation, as you look ahead, if you think about your sector, who do you think is in the driver's seat right now in the eyes of management, do you think it's more friendly to the equity holder, more friendly to the bondholder? Or does it really vary company by company?

David Hamburger: A lot of it varies. Certainly in the interest rate regime we've been under for the last couple of years, the companies and their management teams have been more mindful of the balance sheet and more mindful of leverage. You know, we as credit investors, we're always kind of looking at the downside and the downside risks, because clearly we would just want those companies to pay back debt and always examining again the willingness and ability to do so. But to the extent that there's excess capital and excess financial flexibility, all things equal, you want to make sure they're staying nimble and investing in the business and remaining competitive. And one of the things is, you know, we look at this sectors now with a little more caution because of the amount of leverage, because, you know, there might be a tendency to look at the need to the business and to invest more aggressively should rates begin to come back down. We think the, you know, the higher leverage in the face of rising competition and intensity around consumer and enterprise demand, give us pause with regard to the, you know, these companies ability to to continue to focus on the balance sheet and creditors. And I think that's why, again, you're seeing a lot of these stress situations in this sector in particular. 

Andrew Sheets: David, thank you for taking the time to talk. 

David Hamburger: It's been my pleasure. Thank you. 

Andrew Sheets: And thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcast app. It helps more people find the show.