Question: As of November 2022, the tech industry is going through an extremely turbulent period. Major technology firms including Meta (Facebook) and Amazon have been laying off a significant portion of their workforces on concerns of profitability

As of November 2022, the tech industry is going through an extremely turbulent period. Major technology firms including Meta (Facebook) and Amazon have been laying off a significant portion of their workforces on concerns of profitability, and general investor pressure. From a financial point of view, the employer and the employee are bound by a contract (the job contract), which reflects the expectations that they have of each other. Nominally, the duration of the contract runs until that point when the company and the employee have outlived the mutual benefits that they derive from each other. They are thus, long-lived contracts with no set expiration date. Note: A financial contract is different from a legal contract. A legal contract for a worker might include a specific end date (“contractual” employees) or none (“employment at will”). The above discussion refers to the financial contract and not the legal contract.

A widespread layoff within a firm, in the contracting sense, is akin to the company cancelling its long-dated contracts early. By doing so, the company releases itself from the commitment of paying wages and salaries to its employees, which are fixed in levels and in time. This is because the company knows exactly how much salary it pays its employees, and salary payout always happens in a fixed schedule (once a month or twice a month). Having taken the very excellent Fixed Income course at Tulane, you know that the employment contract is not the only form of long-dated contracts that a firm can take up. Another common form of a contract that has fixed cash outflows in fixed durations in time is a debt instrument, or simply a bond!

The basic intuition of this exercise is as follows: if tech firms are facing difficulties in maintaining their employment-related long-term contracts, we are going to try and understand if the same set of factors also affect their alternative form of long-term contracts, i.e., bonds. The easiest measure of the quality of bonds is to investigate the credit rating of the company. The following set of questions will guide in ultimately judging how the firms’ bond evaluations are changing on the back of widespread job layoffs.

1. Consider the set of the largest technology firms in the U.S. – the FAANG (or, MAANG) firms. These are specifically, Facebook (Meta Inc.), Apple Inc., Amazon.com Inc., Netflix Inc. and Google (Alphabet Inc.). First, identify the stock tickers for each of these firms using Capital IQ. (You can find detailed instructions on how to set up a Capital IQ here). Alternately, you may choose to do this on Refinitiv or Bloomberg – the choice is yours, pick a source that you are most comfortable with.

Clearly state which source you are using, and the tickers for each of these stocks.

2. Now, we need a “baseline” set of companies to compare the above companies against. The baseline refers to a set of firm that would be outside the tech industry, and therefore not subject to the same problems that the tech industry is facing. By seeing how the tech firms compare against these non-tech firms, we can attempt to see how the tech firms are different from these non-tech firms. We will use the largest non-tech firms, which are included in the Dow Jones Industrial Average as our baseline. Pick any five non- technology firms from the list of DJIA constituents.

State here the companies that you choose, their tickers, and why you choose them (1 or 2 sentences for each company that you choose).

3. Now we have a set of 10 companies (5 tech and 5 non-tech). Using your preferred data source, for each of these companies, compute the following financial measures using the latest available financial statements. You can use the built-in financial ratios tool in Capital IQ to these financial ratios, or you can choose to do them on your own..

For each measure, state the inputs and the final computed value (you may choose to present this as a table).

1. 1. EBIT Interest Coverage
   2. EBITDA Interest Coverage
   3. FFO/Total Debt
   4. Free operating cash flow/total debt
   5. Return on Capital
   6. Operating Income/Sales
   7. Long-term debt/capital
   8. Total debt/capital

4. Briefly discuss the key differences that you find between the ratios for each of the 10 companies. Which metric varies the most? Which metric varies the least?

5. Now, based on each of the above measures, we are in a position to impute the credit rating that should be, even if the actual rating has not yet changed to reflect the companies’ financial conditions. To do this, use Table 1 that links the financial ratios to the credit rating.

Based on each ratio that you compute, for each firm, what is the expected credit rating? You may present you answer in the form of a table, like below, e.g.,

6. As you computed the ratios above, you would have noticed that each ratio might imply a different rating for each firm. As the fixed income expert, it is your job to decide which one of these ratings makes the most sense for a particular firm.

Condense the various ratings to one single “best applicable” rating for each, explaining how you do this. For example, you can think of an “average” of all ratings, or most commonly occurring. The choice is yours, but justify your answers.

7. Finally, discuss how the credit rating varies across tech and non-tech firms. In particular,

1. Estimate the bond yields for 10-year and 30-year bonds issued by each firms, using data in Table 2. You can obtain the treasury rates from the Treasury website. Discuss which firms face the highest costs in issuing debt, and which firms are at particularly increased risk of default.
2. Based on your calculations above, what is your opinion on the level of overlap between forces that drive firms to layoff employees and the factors that lead them to abstain from issuing bonds? Do you think the two go hand-in-hand?

Table 1: Key financial ratios by rating category

Table 2: Credit Spreads by rating category and maturity