High yield investors pressured as flush corporates mop up junk
* Corporates flex muscles taking out high yield credits
* Cash-laden investors pressured to buy weaker paper
* Trade buyers trump sponsors in auctions
By Robert Smith
LONDON, Oct 11 (IFR) - Acquisitive investment grade corporates are starting to gobble up junk-rated issuers, taking their bonds out of circulation, which could increase pressure on European high yield investors to pick up weaker paper in the primary market.
"With open primary equity markets and an increase in CEO confidence and strategic activity, we expect to see investment grade corporates taking out high yield credits as part of a growth and consolidation initiative," said Denis Coleman, head of credit finance EMEA at Goldman Sachs.
"This will return cash to high yield bondholders, providing a great technical for new issues on the road."
European investors already have more cash than they know what to do with, according to market sources. One high yield banker said that his team thinks average investor cash balances are between 5% and 7%, compared to the 2% ratio they would be comfortable with.
The concern from some quarters is that this will provide structural support for weaker credits, as investors would rather remain invested than keep running cash balances.
"You're already seeing this new dynamic providing a support for new issues, and I think it's definitely why you've seen so many PIK deals recently," said the banker.
Payment-in-Kind toggle notes had not priced in Europe before this year, and were originally printed only by well known Swiss telecom firms such as Sunrise and Orange Switzerland.
Yet in the past four weeks, three PIK toggles have printed in Europe for a total volume of EUR740m, one even from a Polish television broadcaster. There is also potential for issuance from peripheral Europe, as Italian spare car parts firm Rhiag announced a EUR155m PIK toggle this week but shelved it when the firm was bought out by Apax in the middle of roadshows.
The wave of PIK issuance follows corporates mopping up big high yield names. Vodafone won EU approval last month for its EUR7.7bn buyout of Kabel Deutschland, a high yield stalwart with more than a billion euros of bonds outstanding.
Earlier in September, Microsoft's surprise Nokia acquisition provided a great initial fillip to bondholders, as bond prices rose a whopping 10 points on the news, but as the company aims to return to an investment grade credit profile, its EUR2.85bn equivalent in bonds could also fall out of high yield indices.
Although an uptick in M&A should also bring a fresh wave of LBOs, corporate buyers also pose a threat here too as they can outmuscle the private equity firms that favour high yield.
"We think that corporate interest in acquisitions is at a five-year high, and trade buyers typically can justify paying a higher price than private equity as they can take out costs through synergies," said the banker.
Earlier this week, US-based food business Darling International won the auction for Dutch meat producer Vion's ingredients division. The result was a blow for leveraged finance bankers, who had been preparing up to EUR1bn debt packages for private equity bidder such as Advent and CVC.
"We were backing a couple of sponsors and then Darling swooped in and took it," said the banker.
"It's going to make things interesting for the high yield market, and could mean there is not a huge amount of new M&A supply."
Others in the high yield market are far more sanguine, however, believing that M&A will give more than it takes away.
"It's true that the universe of public bonds outstanding is still relatively small in Europe compared to the US and there may be a few deals that go away, but, on balance, an uptick in M&A is going to bring much more offerings to the market than it will take out of it," said Mathew Cestar, head of leveraged Finance in EMEA at Credit Suisse.
Credit Suisse analysts think the primary market's run still has some way to go, predicting EUR75bn in European high yield volumes for 2013 compared to EUR66bn year-to-date.
Also while investors acknowledge the pressures of names coming out of the index, they suggest that this is tempered by names dropping into the index as well.
"Although there's definitely some technical pressure to buy new issues, I think that with Telecom Italia potentially coming into the high yield space investors are probably going to save some dry powder for that," said Jon Brager, a senior credit analyst at Hermes Fund Managers. (Reporting by Robert Smith, editing by Alex Chambers, Helene Durand and Julian Baker)
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