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Shift in Corporate Financing: Companies Opt for Equity Amid Rising Interest Rates

Published February 28, 2024
4 months ago

The corporate finance world is witnessing a significant shift as chief financial officers (CFOs) are increasingly favoring equity over debt to fund their companies. This trend, highlighted by the financing decisions of specialists like Bryan Riggsbee, former CFO at Myriad Genetics, comes at a time when central banks are steeply raising interest rates. The rising cost of borrowing is pushing companies to seek alternative means of raising capital, leading to a stark departure from the long-standing preference for debt financing.

In a striking example of this shift, Myriad Genetics, a Utah-based DNA-testing company, sold shares for the first time in 16 years, raising $110 million in November. This move illustrates the changing tides in corporate finance, as blue-chip companies in the US are finding it more economical to issue equity rather than take on more costly debt.

The escalation of borrowing costs has been driven by central banks' efforts to battle inflation through rate hikes. With interest rates reaching heights unseen for decades, debt, once the default option for corporate financing, now represents a more expensive and less attractive route for many companies. This has not only affected smaller firms like Myriad but has also reached larger organizations and startups.

Furthermore, equity markets have been shrinking globally for over 20 years, with public listings in decline. The re-engagement with equity by corporations could potentially reverse this trend, referred to as "de-equitization" by Robert Buckland, a long-time equity strategist. A move towards equity could lead to reduced dependence on debt, a loosening of private equity's hold on businesses, and greater public ownership and market transparency.

Although this strategic pivot to equity could, in the short term, result in lowered valuations and higher costs for issuing companies, the long-term implications may be overwhelmingly positive. Increased access to early-stage growth opportunities for investors and creating a more balanced market against the dominance of large companies could be among the benefits observed.

Morgan Stanley's quant models suggest a resurgence in equity issuance, with prospective IPOs from privately funded unicorns on the horizon. As a case in point, Reddit Inc. is preparing for its own IPO, a move which reflects the broader trend of startups considering going public in the environment of rising interest rates.

While these developments suggest a potential shift towards what could be described as "re-equitization," challenges remain. Regulations and the enduring availability of private capital may continue to incentivize some companies to favor debt financing. Additionally, any decision from the Federal Reserve to lower interest rates could again tilt the scales back towards debt.

Nevertheless, with the fundamental metrics of capital costs, such as the 10-year Treasury yield, unlikely to drop significantly, and the reduction of leveraged buyouts and stock buybacks due to increasing debt prices, equity might become the more prevalent means of financing. With finance chiefs now more likely to reach for their "equity checkbooks," the corporate world may be at the cusp of a more pronounced shift in its financial structuring, potentially leading to a diversification and democratization of market participation.

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