When the pandemic hit, cruise ship operator Carnival Corporation had to scramble to secure enough liquidity to survive. Carnival’s Darrell Campbell explains how he navigated the crisis, and his priorities going forward in a revealing insight into liquidity management. For other companies, cash on hand is an opportunity to shore up credit ratings and invest for the future.
The 2020 travails of cruise ship operator Carnival read like a case study in cash and liquidity management. Over the last year, the company has raised over US$22bn in emergency funding to stay afloat in a sweeping liquidity strategy. At first it was just about survival, executing capital market transactions with the highest likelihood of success in a highly challenging environment which wouldn’t handcuff the company in the years to come. Next, the priority was debt transactions that fitted Carnival’s maturity towers with the flexibility to pre-pay, followed by debt conversions as the economic environment began to improve. Most recently, and with dry land finally in sight as the vaccines roll out and the company has begun to sell cruises again, Carnival has stepped back into the unsecured market able to issue bonds not backed by its ships or other assets once again. “Stressful?” asks Darrell Campbell incredulously. “That is the understatement of the year.”
One shot
Survival, and what turned out to just be the start of the process, involved securing a comprehensive combination of debt, equity and convertible debt via a package of over US$6.5bn in early April 2020. “We had one shot to convince investors,” recalls Campbell, speaking from his home in Miami, Florida, explaining that his key consideration at that time was making sure there was enough equity underpinning the capital structure, and navigating a pivot to the secured debt market when the unsecured debt market abruptly closed.
Generating financial models based around different scenarios in such a period of huge unknowns was hard enough. Add in articulating them “on the flack” to a new and unknown investor group and it turned positively challenging. “The group of investors we were targeting were high-yield. Even though our credit rating was still investment grade, we looked like a high-yield company. Our messaging had to be precise, our timing had to be precise and planning for what came next had to be precise.”
The cost of shoring up liquidity was certainly eye watering. On one hand Carnival was locked into a higher rate of borrowing than normal on a secured basis – although the team set this at three years with the view that the company would then be able to refinance at a more favourable rate and without collateral. On the other, a necessary US$600m equity offering in early April coincided with a historic low in the stock price. “Given the circumstances, this was our best course of action. We had to make sure we had the liquidity,” says Campbell.
Two months later and another swathe of transactions followed with Carnival approaching a new set of investors with US dollar and euro term loan B issuances for a combined US$2.8bn last June. This time the debt was structured to give the company the flexibility to pre-pay with call options in anticipation of the recovery. Meanwhile, as Carnival’s outlook began to improve because of its stronger liquidity position, the next tranche of debt came at a better rate.
Come August, the team started to approach investors to convert the debt issued in the heat of the crisis to equity. “This was important to help us deleverage,” he says, adding how timing on this seam of the strategy also coincided with a rebound in the company’s share price to US$14 a share from a low of US$7.80.
In the next wave of financing, against the backdrop of the continued rebound in the share price, Carnival launched a US$1bn ATM programme, followed by another US$1.5bn in October. “When we got to September, we started looking at ways to issue more common stock,” says Campbell. “By this time, we had enough liquidity even in the worst-case scenario and news of the vaccine was starting to come out.” At which point the company also began restarting cruises off Italy and Germany. It was also able to opportunistically return to the unsecured debt market, borrowing US$2bn in November in a bond offering not backed by its ships.
Cutting costs
Cutting costs is just as important in successful liquidity management. Carnival has sold 19 older and less efficient ships over the past year. Admittedly the vessels only represent 3% of the company’s operating income, but not paying servicing costs meaningfully impacts the company’s cost structure. “The new ships coming in are larger and more efficient. This will help to further improve our cost structure as we return to service,” says Campbell. Elsewhere, while maintaining compliance, environmental protection and safety, the company significantly reduced its operating and general and administrative costs and deferred all unnecessary capital expenditure.
As for those new vessels already under construction, the team has put in place deferrals of some principle payments with Export Credit Agencies and banks. “It’s in the best interests of ECAs that we continue to operate successfully and build ships in their countries,” he says.
At the end of last November, Campbell says the company had around US$9.5bn in liquidity. With an estimated Q121 cash burn of US$600m a month, he is confident that even in the unlikely event Carnival’s revenues continue to languish through 2021, the current cash pile will be enough to get the company through the year. Crediting the strategy to his small treasury team working alongside a broader finance, Counsel and legal team within the company plus investment banking partners, he says he will continue to look at opportunistic transactions around refinancing higher coupon debt through the course of the year.
The new ships coming in are larger and more efficient. This will help to further improve our cost structure as we return to service.
Darrell Campbell, Carnival Corporation
Carnival’s strategy is an extreme example of liquidity management for a company caught in the eye of a storm. But scratch beneath the surface, and corporates the world over have plotted a similar course, prioritising liquidity via debt issuance and refinancing costly debt wherever possible. Cheap borrowing costs and easy access to the capital markets meant companies, including banks, raised more than US$6.37trn from investors last year, according to data provider Refinitiv. Elsewhere, Moody’s data reveals cash holdings of US companies has hit a record high due to higher borrowing to bolster liquidity and/or to pre-fund upcoming debt maturities. “In 2020, the top five cash holders remain Apple, Microsoft, Alphabet, Amazon and Facebook,” says Richard Lane, a Moody’s senior vice president.
Moreover, the pace of issuance shows no signs of slowing. With no signs that the Federal Reserve, European Central Bank or Bank of England will increase interest rates any time soon, companies are still using the opportunity to buy back shorter dated bonds and pay down term loans to re-finance with longer dated bonds. Giulio Baratta, Head of DCM Ccorporates at BNP Paribas, says his key focus remains helping companies support their backup liquidity facilities, and refinance in the debt capital markets. “The first priority is liquidity, then balance sheet strengthening,” he says. “We were expecting volumes to start to decrease in 2021, but we haven’t seen that trend yet.”
Nor is investor appetite to lend to companies starting to wane. In fact, many investors are comfortable going down the capital structure and buying subordinated, riskier debt, indicative from inflows into both investment grade and sub-investment grade funds, he says. “Investors were expecting less supply. So far this year they are still supporting transactions although we notice a little more scrutiny in terms of value. Companies will continue to spot opportunities for refinancing, maturity lengthening and locking in these very low rates. We are in a strong position in the debt capital markets and there is only a marginal cost to refinancing.”
M&A
Although Carnival has allocated every drop of its liquidity to staying afloat, other companies have enough on hand to explore different strategies. Piles of corporate cash hoarded as a cushion against falling revenues could now spark a visible pick up in M&A activity, suggests Baratta, who says more enquires around acquisition finance are starting to filter through at the bank, and that a spike in M&A activity is a “core” 2021 expectation amongst the team. It could be either defensive, or M&A activity triggered by companies seeking growth via acquisitions, particularly amongst those struggling to boost revenues, he predicts. “M&A can be a good way of aggregating a business in certain sectors and companies might seek to build their footprint geographically.”
Others are more cautious however, citing ongoing uncertainty and companies perceiving “getting back to normal” as more of a priority than any corporate transformation. “M&A could be difficult to justify in quite a few sectors,” warns Paul Watters, Head of EMEA Credit Research at S&P Global Ratings. Campbell certainly doesn’t predict meaningful M&A activity in the cruise ship sector, although he qualifies this could be more a consequence of the fact the industry only has three big players as it is. All have secured liquidity runways, and with vaccines and recovery in sight, things will soon return to normal, he predicts. “Assuming we all successfully navigate this period – which is my strong expectation – I don’t imagine big players will do M&A. We make up most of the industry and I don’t expect a massive consolidation.”
Invest
Treasury teams could use their cash on hand to invest in the business. Climate change is certainly a pressing issue. The OECD estimates that US$6.9trn a year is required up to 2030 to meet climate and development objectives. Companies that have drawn up future proof, strategic climate strategies including plans for investment to meet accelerating structural trends are emerging as industry leaders. “Anyone wanting to show leadership in their industry in an industrial sense also needs to show leadership in tackling climate change and in their ESG ambition,” says Baratta, who highlights investors increasing preference for best-in-class corporates and those with a solid ESG strategy.
Yet S&P’s Watters says signs of companies using cash to invest have yet to emerge. The latest analysis sees no broad corporate themes regarding capital investment or more particularly in mitigating climate change, he says. “Capital investment continues to be very weak in many sectors. There is still a lot of uncertainty as to when the recovery will become sustainable.”
Payouts to investors given the equity rally could make a comeback, suggests Baratta. “If current valuations come under stress, there could be a rationale for supporting stock.” Not surprisingly, 2020 was the worst year for dividends since the financial crisis, as companies suspended or cut payouts to conserve cash. It remains to be seen whether treasury teams are confident enough of what lies ahead to start to reward investors again; besides, businesses that received state support during the crisis remain under pressure not to reward shareholders too quickly.
Credit rating
One of Carnival’s priorities is to strengthen its credit rating, restoring its investment grade rating by reducing its debt pile and repairing the balance sheet. Carnival’s rating has fallen to B (bonds rated double B plus and below are known as high-yield, or junk) and “as long as markets remain favourable,” Campbell says he wants to try and repair the damage. “Our goal is to rebuild our balance sheet and return to an investment grade credit rating over time. We have historically maintained a strong investment grade credit rating to absorb temporary shocks. As it was, having that balance sheet strength enabled us to absorb some of the COVID impacts.”
It’s a nod to the sharp difference in market access the company felt when it was forced to tap high-yield investors. A strong credit rating provides access to a far larger pool of investors and typically means lower borrowing costs. Most recently, it has also come with central bank support given central banks began buying investment-grade rated companies to support the bond market in the wake of the pandemic.
The best way to improve a credit rating and a company’s financial risk profile is to pay off debt, says Watters. He adds that credit ratings are based on many factors including the state of the industry, the company’s competitive position therein, and its profitability. The pandemic’s impact on growth and earnings has put credit metrics out of kilter and companies’ financial risk profiles under pressure – especially those with weaker ratings. “The obvious way to improve a financial risk profile given the disruption caused by the pandemic is to improve earnings and cash flow,” he advises. As to whether companies are using their piles of cash built up over the past year to cushion them against falls in income, he hasn’t noticed any particular trends yet. For now, key themes include some large companies starting to pay back government support that they may have received. But with little opportunity cost from raising debt and holding cash, most are simply choosing to stockpile liquidity until the business outlook becomes clearer, he says.
Conclusion
There is no doubt that businesses like Carnival and others in hard hit sectors have had it tough. But Watters concludes with a thought for speculative grade corporates and SMEs for whom the capital markets have not been a source of largesse. They have burnt through cash, raised finance through the government loan schemes, and are in a much more vulnerable position. “Many SMEs are seeing their top line under huge pressure and their earnings and cash flow affected. Many have taken on more debt, and so from a credit perspective, their overall credit quality has weakened.” Indeed, he sees a litany of business failures ahead. “A lot of SMEs may not have a strong enough business model to see them through the recovery. It’s not really a liquidity issue – it’s more about having a sustainable capital structure given their business model in a post pandemic world.”
