More NewsFitch: Demergers Cause Uncertainty for Debt Investors

Fitch: Demergers Cause Uncertainty for Debt Investors

Companies choosing to exit businesses through demergers cause uncertainty for debt investors and increase the leverage of the aggregate cash flows of the independent businesses that result from the demergers, says Fitch Ratings.

The credit rating agency (CRA) says, in a special report entitled
‘Demergers – A Concern for Debt Investors’
, that the impact of the process on debt investors is of particular interest following a recent spate of demergers and demerger proposals in Australia.

The report examines the early warning signs, the protections and the possible options available to bondholders to identify and mitigate exposure to demerger-related credit risk migration.

The segmentation of a borrower’s cash flows poses several risks to bond holders, Fitch says. Demergers sometimes result in bond holders losing credit protection from a parent guarantee. In other cases bond holders may be disadvantaged by the lack of sectoral or geographic diversification provided by the consolidated business.

Managements of companies seeking to demerge use cash distributions – in addition to other capital distributions – to incentivise shareholders to vote in favour of the proposal. The loss of capital (capital is distributed to shareholders) exposes bonds to increased financial risk and, therefore, lower prices and higher secondary market yields. Moreover, post demerger leverage rises as a result of significant transaction expenses, the replication of administrative cost bases and the increasing lack of synergies.

The report entitled is available at www.fitchratings.com.

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