While the lower tax rate is definitely a positive, Bloomberg’s Gadfly column waves the caution flag on the spinoff citing its high level of leverage and a slowing macro environment. As part of the separation, Adient will pay JCI a special dividend of $3b which will be entirely funded by new debt. So where does that leave Adient’s balance sheet?
The company is expecting to wind up with a debt load about twice its Ebitda — above what a Bloomberg Intelligence study conducted by Joel Levington found was the optimal range for the industry in terms of share outperformance.
Although these special payouts are quite a common feature of spinoffs, the associated levels of leverage at the spinco level are increasingly coming under scrutiny. For example, many point to the leverage levels for the differing performance amongst the recent print spinoffs (this is an entirely different piece). High levels of debt can limit the flexibility of companies, especially those which are already struggling with poor performance. In this case, Adient’s operating margins are below its peers, but don’t worry – the company plans on closing that gap over the next few years. Furthermore, if the industry cycle takes a turn for the worse, high levels of leverage exacerbate the pain. Bloomberg notes that the auto industry has been flying high recently, but signs of weakness are already emerging. US sales data recently underwhelmed and in Europe, a continent in which Adient generates a sizable portion of its revenue, there is fallout from events (non-events?) like Brexit.
Bloomberg closes off on a negative note, saying that ‘it’s hard to see Adient roaring out of the starting gate’. Perhaps, but sometimes the market overreacts to the spinoff of so-called ‘bad companies’ and of course leverage cuts both ways. As a reminder, the spin is expected to be completed in October and that this will NOT be a tax-free spinoff.
Disclosure: Author holds no position in any stock mentioned.
Mentions