Schafer: Fears about Medtronic debt appear misplaced

It was just plain puzzling to read in a major financial journal like Barron's last week that the debt burden of Medtronic PLC may be a problem.

The columnist said debt has swelled to a "staggering $37 billion." Gosh, that does seem like a lot — although I calculate a much smaller number, more like $17 billion.

How can there be such divergent views on something as seemingly black and white as what a company actually owes? The reason is that Medtronic, an Ireland-based company run out of headquarters in Fridley, isn't as easy to understand as it once was.

One reason for that is how it financed the cash portion of its recent acquisition of Covidien — borrowing even though, on paper, that didn't appear to be necessary.

Taking on a bunch of debt wasn't the plan, of course, back when Medtronic first announced the Covidien deal last June. It planned to spend its cash and investments stashed offshore, roughly $14.4 billion as of October.

Technically, the foreign subsidiaries were going to "loan" that money to an affiliate to fund the Covidien deal. But the important point was that Medtronic was planning to use Medtronic's cash to fund Medtronic's acquisition.

Then the U.S. Treasury stepped in with new rules on the very kind of intracompany loans Medtronic was planning.

In December Medtronic did so, in one day selling $17 billion in bonds. And with those $17 billion in bonds on top of the debt Medtronic already had and some more it took on when it closed the acquisition of Covidien, the "gross" debt has crept up to more than $36 billion.

On the other hand, that $14.4 billion in undistributed cash profits from old Medtronic's foreign subsidiaries hasn't gone anywhere. That means the net total of what Medtronic actually owes is nowhere near $36 billion.

This calculation is called "net debt," an important one in finance. It's simple, too. If you hit up a buddy for $100 to get through the weekend yet still have $50 come Monday morning, it's not hard to figure out that just $50 needs to come out of the next paycheck to pay your friend back.

Medtronic hasn't released a balance sheet yet, but its CFO described the newly merged company's debt situation on a recent conference call with investors.

Based upon what he said, the newly merged Medtronic has total cash of $18.9 billion and the back of the envelope calculation puts net debt at around $17.2 billion.

According to a company spokesman, by the end of its April 2018 fiscal year, Medtronic expects that net debt will be down to about 0.7 times its cash earnings, or earnings before interest, taxes, depreciation or amortization. By that standard measure, the company clearly will have no problem meeting its obligations and still buy back stock, pay dividends and invest in its business.

But curiously, when this airtight case for Medtronic as a borrower was run by some bond investors this week, they said they didn't find Medtronic's big stash of offshore cash quite as comforting as I did.

For one thing, bond investors don't always trust companies to use excess cash in any way that helps them. Shareholders love stock buybacks, for example, but the bondholders and lenders sure don't. Stock buybacks just drain money from the company and raise their risk.

Another reason, said analyst Andrew Leeser with Thrivent Financial, "is that a lot of that cash sits offshore. That's not necessarily cash that is going to be used to pay down that debt," as it would still be subject to U.S. tax if it went to pay interest on some bonds.

And maybe that's the most curious aspect of this discussion of Medtronic's debt. It has more than $14 billion held in the offshore subsidiaries of its former U.S. corporation, without much apparent value. That money is out of sight for bond investors, and, apparently, best put out of mind.

And Medtronic bonds are the highest priced, meaning bought and sold at the lowest yields, of any medical device company bonds he tracks.

Medtronic's new 10-year bonds this week were trading at less than a 3 percent yield. Any company that can borrow money for 10 years that cheaply doesn't appear to be overleveraged.