The strong growth in technology debt over the past decade has raised concerns that a bubble may be forming. With memories of the telecom, housing and energy bubbles fresh in many minds, it is easy to see why these anxieties arise (Figure 1).
Figure 1. Where’s Your Bubble Now?
Analysis as of March 12, 2018. Source: Bloomberg Barclays and Voya Investment Management. Industry weights as represented by the market values of the Bloomberg Barclays Corporate Bond Index and the Bloomberg Barclays US High Yield Index.
However, the data shows that technology fundamentals are generally healthy. Not only did tech new issuance come to halt at the end of 2017 when tax reform went into effect – essentially ending any expansion of a would-be bubble – many of the deals came to market as a financing mechanism to access overseas cash. As such, these deals are in essence backed by liquid collateral – i.e. actual cash – and less tied to the success of capital-intensive projects, commodity prices or corporate transactions, as was the case driving debt growth in the bubbles mentioned in figure 1. It is worth noting that this dynamic is not exclusive to technology, but also applies somewhat to other highly credit worthy, cash-rich issuers.
But even beyond the cash-rich nature of each Technology deal, a combination of strong credit fundamentals supporting the outstanding issuance, the industry’s robust free-cash-flows, and a more cash-flow friendly shifting of the industry’s cyclical structure gives us confidence that serviceability of the debt is not likely to be an issue any time soon.
When tech new issuance came to halt at the end 2017 almost 90% of the outstanding debt was rated single-A or higher. Indeed, gross and net leverage in the industry is currently 0.2 times EBITDA. Therefore, any issuer-related problems that could arise would be idiosyncratic and unlikely to have a beta effect on peers.
Meanwhile, since the turn of the 21st Century the technology industry has become less cyclical in that it is more consumer oriented and less dependent on demand for semiconductors, providing a more stable flow of cash for debt servicing. So much so that free-cash-flow as a percent of debt is over 30%, meaning that with free cash flow alone tech companies could repay all of their debt in roughly three years.
So while the pace of new issuance in the technology industry would appear to indicate the formation of a bubble, several key factors make this highly unlikely. With tax reform removing the primary incentive for Technology companies coming to market, strong credit fundamentals and enough cash on hand to facilitate an orderly deleveraging on its own, any potential bubble is more likely to see a slow deflation rather than a sudden pop.
The Path Forward: Navigating Volatility
While it does not appear that a bubble is forming in the technology industry, tech is not immune from the recent market volatility that has injected an element of uncertainty across the broader credit markets. The recent volatility has also led to increased dispersion among industries and issuers, creating opportunities for fixed income investors. In this environment, security selection remains key as idiosyncratic risks among issuers are being magnified.
Of course, security selection alone cannot protect against a downside market move in the later cycle stages of the credit cycle. It may deliver outperformance versus a lagging industry but probably not relative to the market. As this analysis highlights, having a deep understanding of individual credits and the relative value of industries is a critical combination in today’s uncertain market environment.
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