Bondholders beware: event risk is back

Fri Mar 8, 2013 4:53am EST

* M&A activity tipped to pick up with LBO prospects

* Change-of-control language still relatively rare

* Small and medium sized corporates most likely targets

By Natalie Harrison and Josie Cox

LONDON, March 8 (IFR) - Investment-grade bondholders may find themselves unprepared and at the centre of an event risk minefield if cash-rich corporates and private equity firms, encouraged by a sustained equity rally, embark on an acquisition spree.

After a dismal two years for M&A activity, bankers are hopeful that two to three mega leveraged buyouts - reminiscent of the 2006-2007 leveraged buyout boom - could materialise in Europe in the second or third quarter, with each involving EUR10-15bn of debt,

But while this is good news for fee-hungry bankers, it's a chilling prospect for some high-grade bondholders.

Britain's biggest mobile operator Everything Everywhere and French media giant Vivendi's SFR mobile unit have emerged as targets, and there are plenty of potential buyers.

Vodafone, for example, has been linked to cable companies ONO, Kabel Deutschland, and Yoigo in the past few weeks, and has also shored up its funds via a huge USD6bn bond issue in recent weeks.

Rating agency Moody's warned on Thursday that the proposed USD23.2bn buyout of U.S. food giant Heinz by Warren Buffett's Berkshire Hathaway and 3G Capital could leave some Heinz bondholders in a far weaker position in the company's capital structure.

Almost USD900m of Heinz's current USD4.3bn of outstanding bonds will remain in place after the deal closes, and could be junked due a doubling in leverage, Moody's said.

"The deal is a reminder to investment-grade bondholders that their often minimal covenant protection can leave them exposed to a sharp decline in value after an acquisition is announced," said Moody's analyst Alexander Dill.

"It also illustrates the particular importance of change-of-control provisions in bond covenants, though these were less common in investment-grade indentures before the leveraged buyout boom of 2006-07."

Despite clear signs that takeovers are picking up, only 37% of high-grade non-financial issuance documents contained change-of-control protection clauses last year, according to Bank of America Merrill Lynch data. So far this year that number has fallen to 31%.

Among recent investment-grade issuers that have included change-of-control language are German auto parts supplier Hella KGaA Hueck & Co and Everything Everywhere.

Spanish conglomerate Abertis Infraestructuras, however, did not, and sold a EUR750m seven-year bond on the back of EUR4.5bn orders, despite in 2010 having been at the centre of takeover speculation.

TAKING A LIBERTY

Change-of-control covenants will put a floor on the value of a security - usually 101 - but this still leaves investors exposed if the bonds are trading well in excess of that level.

Liberty Global's acquisition of Virgin Media last month, for example, resulted in a 12-point drop in the price of the latter's 2021 investment-grade rated secured bonds.

"In the high-yield market event risk is typically positive, as you are more likely to be taken over by a company that is higher rated than you, but in the investment-grade market, negative implications can be significant," said James Gledhill, investment fund manager at AXA IM.

Identifying acquisitive companies, by looking at their cash holdings and liquidity, is quite straightforward. The problem lies in identifying who might be the targets, investors say.

In high-yield, it tends to be the most cash-generative companies, but Virgin Media bondholders clearly didn't see Liberty coming.

The Heinz deal and Dell's USD24bn buyout are the first proposed leveraged buyouts worth over USD10bn since the financial crisis, and the odds are that the pace of takeovers will quicken in Europe.

"Capital markets bankers are telling us that there will be a large amount of leveraged loans coming our way. There's usually a three-month time lag from the bid to financing, but the third and fourth quarters could be busy," said one leveraged loan investor.

"Bankers are certainly saying that this is the busiest they have been in three years."

Corporate confidence is clearly on the rise too.

"We are...open to small and medium sized acquisition opportunities to achieve this aim of diversifying from mobile to fixed line," Hans Tschuden, chief financial officer of Telekom Austria told IFR.

Leveraged financiers are saying there is a lot of gung-ho M&A talk and banks are conducting discussions on underwriting.

"The Liberty Global Virgin Media deal got everyone excited. The fact is there has been a relative lack of supply, and that is pushing people to be more ambitious."