Many companies rich in cash have used the current panic in the credit markets to buy back its debt at deep discounts to par value, allowing the companies to deleverage, and reduce interest expense and make it easier to comply with covenants. This will help them survive the financial and credit crisis.
Xilinx Inc. (Nasdaq:XLNX) reported in its last quarter that it bought $241.1 million principal amount of its bonds at a cost of $146.3 million. Jon Olson, the CFO of Xilinx said during the fourth quarter conference call "this unique opportunity to improve long-term shareholder value presented itself due to the unsettled credit markets causing the overall convertible debt market to trade at deep discounts. In the short-term, we view this as an excellent way to leverage our strong cash position." Xilinx ended the quarter with $1.29 billion in cash and other short-term investments
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Another technology company to buy its own debt is Amkor Technology (Nasdaq:AMKR). Amkor purchased $118 million in notes during the fourth quarter and committed to buy another $33 million after the quarter ended. The company spent $105 million to make both purchases for a discount to face value of 30%. Management indicated that it was watching its liquidity before deciding to do more. "We do look at debt repurchases from time to time and we do have to obviously balance on what our liquidity position is today, and with the demands on liquidity are between a maturity date to make sure that our liquidity will remain sound," said Joanne Solomon, the CFO.
Autonation (NYSE:AN) also bought back some of its debt. In the quarter ending December 31, 2008, the company repurchased $144.8 million of its senior debt. The purchase led to a pretax gain of 14 cents. During the conference call Michael J. Short, the CFO of Autonation said that the purchase was at an "average discount of 30% at face value." There is some irony in these actions by Autonation because in 2006, the company levered up to buyback stock at the urging of large shareholders. (Find out what these company programs achieve and what it means for stockholders; read A Breakdown Of Stock Buybacks.)
CIT Group (NYSE:CIT) took many actions during the fourth quarter to boost capital, including issuing equity to the U.S. Treasury and a complex series of debt for equity exchanges. It also purchased $360 million face value of its Euro and Sterling denominated bonds for $250 million.
When a company purchases its own debt, it is considered extinguished for accounting purposes. Thus usually triggers a taxable gain equal to the difference between the face value and the price paid.
So why do companies do this? Since the debt is extinguished, the company saves on interest expense. For Amkor, the company will save $11 million a year in interest expense. The reduction in debt also helps a company meet its covenants related to total indebtedness and other financial measures. Autonation said that the buyback and other cost cutting helped keep its leverage ratio at 2.45, below the 3.00 maximum allowed in the covenant. (Learn more in Corporate Bonds: An Introduction To Credit Risk.)
Technology and other companies with excess cash are using it to buy back its own debt, reducing interest expense and making it easier for a company to meet its bond covenants. This is probably the right action to take to assuage the markets current paranoia regarding leverage.