Wednesday, May 09, 2012

In Spain, a Debt Crisis Rooted in Corporate Borrowing

Florentino Pérez, the chief of Grupo A.C.S. The company, saddled with a 9 billion euro ($11.7 billion) debt pile is in the midst of a frantic campaign to distance itself from the Spanish economy.

LONDON — In a country with one of the highest levels of company debt in the world, few businesses in Spain shoulder as big a burden as Grupo A.C.S., the global construction giant whose debt woes have become a mirror image of Spain’s own increasingly fraught financial struggle.

Saddled with a 9 billion euro ($11.7 billion) debt pile that is twice the size of the company’s shrinking market value, A.C.S. is in the midst of a frantic campaign to sell off assets, pay down debt and further distance itself from a Spanish economy caught in a vicious spiral of austerity and deflation.

To date, it has been the Spanish government’s harsh budget cuts and their depressive effect on the economy that has prompted foreign investors to sell Spanish stocks and bonds in droves.

But economists now say that the greater threat to Spain could well be the snarl of debt choking off the growth prospects of A.C.S. and other highly indebted Spanish corporations. And they warn that as these companies cut back on investments and shed assets as well as jobs, the end result could be a Japan-style lost decade of economic stagnation.

A key metric in the euro zone debt crisis has been government debt as a percentage of the total economic output, and Spain has a relatively low ratio of 70 percent, compared with 165 percent for Greece and 120 percent for Italy.

But according to a recent report by McKinsey on global debt, Spain’s nonfinancial private-sector debt is 134 percent of gross domestic product, higher than any major economy in the world with the exception of Ireland, where the figures are skewed by the outsize presence of foreign multinationals.

Factoring in bank, household and government obligations, the total figure rises to 363 percent of GDP, trailing only Japan at 512 percent and Britain at 507 percent.

“The problem in Spain is not government debt, its private-sector debt,” said Jonathan Tepper of Variant Perception, a London-based research boutique with an expertise on Spain. “A.C.S. perfectly captures this problem.”

Under the stewardship of its ambitious chairman, Florentino Pérez, A.C.S., like many other corporations in Spain during the recent boom, gorged on cheap debt to diversify by buying large equity stakes in companies both inside Spain and out.

In a bull market, this web of cross-holdings held in special purpose vehicles and financed by bank loans can sustain a vast corporate appetite. But when the assets backing these debts plunge and the banks call in their loans, the very opposite can occur.

“It is a really bad time for these companies,” said Mauro Guillen, an expert on Spanish multinational companies at the Wharton School of the University of Pennsylvania. “The government is no longer investing in infrastructure, the municipalities are no longer paying their bills and the companies are in constant need of refinancing from their banks. So they have to unload their positions to raise cash.”

With its 28 billion euros in revenues, Actividades de Construcction y Servicios is one of the largest building services companies in the world and as a result of an aggressive overseas expansion program over the past decade its projects range from building subway stations in New York City (namely, the 72nd Street station on the new Second Avenue line) and managing toll roads in Florida, to collecting waste in France and building wind farms in Brazil.

But for the growing legion of investors that has been betting against the company by selling its shares short, A.C.S.’s still significant exposure to Spain’s ailing construction industry and austerity-bit municipalities fuels their bearish outlook.

Credit Suisse, in a recent report, warned that 48 percent of the company’s cash flow comes from various Spain-related infrastructure projects. Tellingly, the bank said, 70 percent of that income is expected to be paid by austerity-bound government entities.

More than anything though, it is the 6 billion euros in debt that A.C.S. has used to buy a controlling stake of the German construction company Hochtief and a similar, but now thwarted move to take over Iberdrola, the Spanish utilities giant, that is at the heart of investor concerns.

“The debt of this company has gone out of control,” said Javier Suarez, a utilities analysts at Nomura in Madrid.

The stock’s decline has accelerated in recent weeks — it is down 40 percent for the year and fell 27 percent in April alone — as it became clear that the more Ibedrola fell, because of concerns about regulatory pressures and its own high debt level, the worse A.C.S.’s financial position became.

Bowing to pressure from banks and investors, A.C.S. reversed course on its Iberdrola strategy last month and sold a 3.6 percent chunk of its stake at a loss, bringing down its position in the company to just under 15 percent.

“Spanish corporates and households are paying down debt massively,” said Richard C. Koo, an economist at the Nomura Research Institute in Tokyo who has been warning for some time now that Europe is entering the same type of balance sheet recession that plagued Japan in the 1990s. Indeed, he and others argue that it is this relentless private-sector downsizing in Spain — by individuals weighed down by mortgages and corporations tethered to their boom-time loans — that threatens to make the Spanish economic collapse semi-permanent as opposed to cyclical.

Jobs are lost, companies have stopped investing and assets have plunged, from house prices to the stock market, which is already down 18 percent this year, the worst by a wide margin among major merging and developed markets — all compounded by the government’s own austerity drive.

In many ways, A.C.S. is a product of its chairman, Mr. Pérez, who, after Emilio Botin of Santander Bank, is perhaps the most commanding business figure in Spain due in large part to his position as president of the soccer club Real Madrid.

Trained as an engineer, he gave up a career in politics in 1983 to buy into a bankrupt construction firm and then presided over a succession of mergers that culminated in the formation of A.C.S. in 1997.

Just as he has used leverage to accelerate his company’s remarkable growth, he has borrowed heavily to finance a parade of splashy Real Madrid player acquisitions — from the British star David Beckham to current the Portuguese sensation, Cristiano Ronaldo.

Relative to his wealth, Mr. Pérez, who owns 13 percent of A.C.S. (worth about 550 million euros and down 56 percent over the past year), is known for his austere personal tastes. He does not drink nor does he often vary the color of his blue suit and shirt.

While soccer-mad Spain may excuse Mr. Pérez for piling on an estimated five hundred million euros of debt on to the team, investors in a public company tend to be less forgiving, especially as A.C.S., unlike Real, must publicly account for its rising debt levels.

To be sure, A.C.S. remains a profitable company. It earned 962 million euros last year and many of its diverse overseas operations are thriving, especially those in faster growing markets such as Latin America.

An A.C.S. spokesman said Mr. Pérez and other executives were not available for interviews.

But in comments to analysts while reporting 2011 results in March, Mr. Pérez emphasized the importance of speeding up asset sales to further reduce the company’s debt burden and he pointed to the company’s 66 billion euros in backlogged business as a sign of its strength.

Its most vigorous (if not long-suffering) supporter is Southeastern Asset Management, a value-based investment company based in Memphis that owns 7.5 percent of A.C.S., making it the company’s fifth largest shareholder.

Southeastern’s main international fund was down 20 percent last year, due largely to A.C.S., the fund’s second-largest holding, putting it among the worst performing mutual funds in its category as ranked by Morningstar, the mutual fund tracker.

In its most recent letter to investors, Southeastern took pains to justify its significant exposure, writing that A.C.S. “sells for approximately half of our valuation because the market oversimplifies this as a Spanish business with optically high leverage.”

But in a global marketplace that has become obsessed with debt, be it sovereign, household or corporate, optics can count for a lot, especially when they are backed by numbers that are all too real.

NYT

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