Technology, media and telecom (TMT) and healthcare were the two most distressed sectors in the Morningstar LSTA US Leveraged Loan Index in 2023.
Combined, the two industries accounted for almost half (48%) of all default volume in the Morningstar LSTA US Leveraged Loan Index for the last 12 months, despite making up roughly a third (33%) of the share of issuers during the same period. Similarly, the two industries accounted for roughly half of the Morningstar US High-Yield Bond Index’s distressed bond issues.
Furthermore, TMT and healthcare account for an elevated share of all distressed loans (performing loans priced below 80) in the loan index, and the weighted average bid price of these two sectors has lagged that of all loans in the index for the last 12 months.
Elevated interest rates have impacted leveraged companies universally, but a combination of secular and company-specific factors have made these two sectors particularly vulnerable to the higher cost of capital, according to market sources.
TMT companies have grappled with changing consumer preferences, skyrocketing capex, a cyclical ad market, tech disruption and the Hollywood strikes, according to market sources. Healthcare issuers have struggled with low patient volume and inflationary pressures on top of regulatory hurdles, sources said.
Cord-cutting has accelerated since the pandemic’s arrival in 2020, with streaming platforms plundering the once-vast subscription bases of satellite and cable TV, resulting in eroded margins and weakened liquidity at traditional media companies, market sources said.
“Unless they find something else to add to their business, there is a real risk that they may ultimately go away,” Andrew Hede, head of turnaround and restructuring practice at consulting firm Accordion, said of telcos.
Hede compared telcos to Kohl’s, saying, “If you look at someone like Kohl’s, they became a return center for Amazon; it probably is not a major source of revenue, but it helps drive traffic to the stores. [Telco companies have] to find [their] niche to drive revenue.”
Along those lines, DISH Network, recently acquired by EchoStar (Nasdaq: SATS), is trying to breathe new life into its business by building out a 5G wireless network. In the process, DISH has run up its debt load and capex to eye-popping levels at a time when its core satellite TV business, which was meant to finance its 5G buildout, recorded heavy losses in the third quarter of 2023. DISH TV’s subscriber count fell 11.7% to 6.72 million as of Sept. 30 from 7.61 million a year earlier.
One bright spot may be that TV broadcast and radio companies, such as Sinclair Inc. (Nasdaq: SBGI), Gray Television Inc. (NYSE: GTN) and iHeartMedia Inc. (Nasdaq: IHRT), are poised to harvest record levels of ad spending during the 2024 election cycle, according to market sources. Ad agency GroupM is forecasting roughly $16 billion of ad spending in 2024, up 31.2% from the 2020 presidential election year.
However, it should be noted that neither industry has been immune to evolving consumer tastes. Broadcast audiences are dwindling and over-the-top platforms, search engines, and social media are siphoning off ad dollars, according to market sources.
Scott Borenstein, an investment partner at Canyon Partners, cautioned that if TV broadcast companies see their share of ad dollars soften, investors will have to rethink their strategies when approaching this space.
“The dual revenue stream of retransmission for broadcasters is finally starting to come under some pressure as overall subscribers start to fall,” Borenstein explained, referring to the subscription and ad revenues shared by distributors and networks.
Falling subscriptions and audience numbers have also had a secondary impact on broadcast companies in the form of distribution agreements. For example, financial pressures have forced many home shopping channels, which have historically paid broadcast companies to air their content, to “renegotiate these contracts or stop paying to distribute the content altogether,” said Eugene Lee, managing director of capital advisory and special situations at Lincoln International.
It’s not just long-term secular headwinds that are dragging down TMT either. The Hollywood strikes brought production to a standstill and thinned out the number of new theatrical releases, meaning movie houses, such as AMC Entertainment Holdings Inc. (NYSE: AMC), could not rely on a slew of blockbusters to lift ticket sales. The strikes delayed the October 2023 release of “Dune: Part Two” twice before its distributor Warner Bros settled on a final release date of March 1, 2024.
However, a couple of market sources struck a more optimistic note, with Borenstein, for one, saying he believed the issues “will resolve themselves. It would not be in anyone’s best interest to have a negative impact on the overall ecosystem.”
Tech disruptions are filtering down to media services companies as well. For example, up-and-coming vendors with potentially disruptive technology are challenging legacy players in the marketing measurement space, noted Jay Weinberger, a managing director in Houlihan Lokey’s financial restructuring group.
“These [legacy] companies have a very big ‘media metrics’ type of business where they employ a significant number of people,” Weinberger said. “But they are facing new competitors who employ AI and it is a lower cost product.”
Healthcare is still reeling from pandemic-related pressures, such as rising wages, as well as from inflation-driven cost increases.
Arguably, compensation poses the most troublesome expense for healthcare issuers today, but Geoffrey Coutts, a managing director in Houlihan Lokey’s financial restructuring group, said the labor issue extends beyond companies struggling to retain and replace labor.
“The skilled labor issues are not just a matter of wage inflation or the competition for talent from competitors, but also the ease in which labor can leave, start its own practice and compete,” Coutts said. “Physical therapists are a good example of this. So not only do you have the issue of your labor being more expensive, you are experiencing higher turnover and your labor is going to compete with you.”
Labor shortages are pronounced across the board, particularly in specialty fields. In ophthalmology, roughly 550 doctors are retiring every year, with only 450 residency graduates replacing them, according to Coutts.
Other market sources noted the talent war has also had a significant impact on physician rollups, causing compensation costs to outstrip reimbursement rates, which have been limited or even lowered by public payors, according to market sources.
Lincoln’s Lee noted that these actions by public payors in turn provided private payors sufficient leverage to renegotiate their contracts to reduce the premium they pay over public payors. He added that rollups historically relied on acquisitions to grow into their capital structures — a model that the higher rate environment has upended by making it difficult to finance acquisitions (Sofr is up roughly 320 bps over the past 18 months).
“As a result, many roll-ups have been unable to rely on the multiple arbitrage afforded by consolidating smaller practices at lower multiples to sustain their capital structures in the current higher rate environment,” Lee said.
Meanwhile, many hospital operators still face pressures on patient volumes, market sources said. People are delaying and foregoing elective procedures or are using telehealth services instead of going to a hospital.
“[That] has created a different demand cycle,” said Bob Del Genio, co-leader of FTI Consulting’s corporate finance and restructuring segment’s New York metro region. “People are also using emergency rooms because they do not have the insurance or the coverage to go somewhere else, which puts pressure on hospitals and health systems as well.”
While drug approvals and uncertainty around the R&D process has always been a feature in the US healthcare system, these two factors weigh more heavily on healthcare companies today than in the past, added Houlihan Lokey’s Coutts.
“Many leveraged healthcare businesses are stretched on liquidity and cash flow due to high interest costs and margin compression that has been caused by rate pressures and inflation,” Coutts said. “They cannot fully make up for the margin compression with rate increases, as our healthcare system is not designed for high inflation, and having stretched liquidity makes it harder for them to weather delays.”
The profitability of healthcare companies is also closely tied to regulations, with the No Surprises Act (NSA) featuring prominently in Chapter 11 cases since being put into effect in January 2022.
Where companies historically relied on commercial payors or the patient directly to offset losses from reimbursements rates from public payors, NSA has rendered aggressive billing practices “unlawful,” noted Eitan Arbeter, portfolio manager and partner at Oak Hill Advisors.
“Thus, the earnings power and consequently the business models of certain providers are being called into question,” Arbeter said.
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