A fascinating article in last week’s Financial Times explains how big businesses can obtain a lot of finance from their suppliers without reporting it as a loan on the company’s balance sheet, even though they are required to pay interest on the amounts owed. US telco AT&T appears to be an especially big fan of this form of finance, with around USD10bn borrowed in recent quarters using methods it describes as ‘direct supplier financing’ and ‘vendor financing’. Adding such figures to the totals owed to suppliers instead of including them in the total for conventional loans helps to generate a more favorable impression of the company’s financial performance. The Financial Times observes:
AT&T has a lot of debt. The US telecommunications company’s total borrowings stretch well north of $130bn, a bigger debt pile than many countries.
AT&T also has a lot of what could be termed “hidden debt”. Hidden, that is, until a recent accounting change cast a light on billions of dollars of liabilities buried in its books for the first time.
The juicy parts of AT&T’s supplier financing schemes are disclosed in Note 11 to the March 31 consolidated financial statements. All monetary figures quoted below are multiples of millions.
Direct Supplier Financing
We also have arrangements with suppliers of handset inventory that allow us to extend the stated payment terms by up to 90 days at an additional cost to us (variable rate extension fee). All payments are due within one year. We had $5,129 of direct supplier financing outstanding at March 31, 2023 and $5,486 as of December 31, 2022, which are included in “Accounts payable and accrued liabilities” on our consolidated balance sheets. Our direct supplier financing is reported as operating activities in our statements of cash flows when paid.
In connection with capital improvements and the acquisition of other productive assets, we negotiate favorable payment terms of 120 days or more (referred to as vendor financing), which are reported as financing activities in our statements of cash flows when paid. For the three months ended March 31, 2023 and 2022, we recorded vendor financing commitments related to capital investments of approximately $1,021 and $954, respectively. We had $5,003 vendor financing payables at March 31, 2023, with $3,531 included in “Accounts payable and accrued liabilities” and $6,147 vendor financing payables at December 31, 2022, with $4,592 included in “Accounts payable and accrued liabilities.”
In summary, AT&T borrows from suppliers of handsets, capital assets, and other ‘productive’ assets. AT&T’s handset suppliers were owed USD5.1bn at March 31 under an arrangement where the suppliers are paid interest if AT&T chooses to give themselves additional time to pay. This allows AT&T the option to take up to 90 additional days to pay handset suppliers. The capital and productive assets bought under the ‘vendor financing’ category are acquired through deals where the supplier has given AT&T an extended period to pay (120 days or more) in exchange for a higher gross amount paid. The difference between what AT&T pays under these vendor financing arrangements and the amount they would have otherwise paid is effectively the same as the interest on borrowing the amount owed.
There is nothing technically wrong or immoral in what AT&T is doing. It is interesting because AT&T is getting a significant portion of its finance by making arrangements with vendors that do not involve banks. USD10bn of borrowing is coming from these rolling arrangements with vendors, compared to USD124bn of long-term debt. The cost to AT&T of these vendor financing arrangements has exceeded USD4bn in both 2021 and 2022. To put this into perspective, Verizon only reported USD320mn of vendor financing payments in 2021, and none in 2022 because the total was not deemed large enough to be material to the accounts.
One potential risk to AT&T, and by extension to its shareholders, is that a shock to the supply chain would also have a knock-on impact on the company’s cashflow. Such a shock is not so hard to imagine following a period where supply chains were disrupted by a pandemic, and because increasing international hostility could interrupt the supply of the chips that are vital to handsets. Suppose China attempted an invasion of Taiwan. More than half of the world’s semiconductor manufacturing occurs in Taiwan. This would almost certainly lead to delays in the manufacture of handsets.
Even if handset manufacturers could maintain the same volumes, they would likely need to increase prices to offset the increased costs as the world rushed to find alternatives to Taiwan’s dominant supplier, the Taiwan Semiconductor Manufacturing Co, which is an important supplier to Apple amongst others. It is reasonable to suppose that sales of handsets would fall, at least for a while. But AT&T is not just obtaining handsets, it is also borrowing money from handset suppliers. They will not be able to borrow if the supplier goes bust, so there could be a sharp correction if suppliers feel unable to continue providing this form of finance or insist on higher rates of interest. So the obviously negative impacts of a war in Taiwan would be exacerbated by pressures on this ‘hidden’ form of financing.
AT&T’s shares are currently trading at their lowest level in almost 30 years. The most recent falls have been blamed on the potential need to replace lead-clad cables considered to be a health risk, though AT&T has rebutted suggestions that they represent a major source of lead in the environment. There has been a more general downward trend in the shares of AT&T and other US telecoms companies in recent years. A lower share price means a higher cost of financing the business, which is unwelcome at a time when there is pressure to upgrade mobile networks and lay more fiber to the home. This increases the attractiveness of alternative sources of finance such as vendor financing, but this also means investors need to be conscious of liabilities that may not be reported in the most obvious parts of a company’s balance sheet.
For a more comprehensive analysis of how AT&T is using vendor financing, and why it is necessary to correctly interpret the scale of vendor financing within a company’s accounts, you can read the Financial Times article here (registration may be required).