As M&A surges, bonds get smaller piece of the action

Fri Jul 18, 2014 12:13pm EDT

NEW YORK, July 18 (IFR) - Bankers are welcoming the heady surge in M&A activity but the bond markets are unlikely to get as big a piece of the pie as in years past, as borrowers make more use of both equity and loans.

Global M&A activity for the year is already at a whopping US$2trn - up 75% from the year-ago period, according to Thomson Reuters Deals Intelligence.

And deal sizes are big: eight deals larger than US$5bn were announced just this week alone, and year-to-date M&A deals above that threshold are more than triple last year, it said.

But as banks struggle with a lack of lending growth, they look increasingly willing to support large acquisitions with term loans.

Meanwhile borrowers worried about the impact on credit ratings are keen to avoid increasing leverage, making other financing options more appealing.

"Unlike last year, when companies relied heavily on the deep fixed-income markets to fund acquisitions, this year we might see the composition of takeout financing becoming more balanced between equity and debt to mitigate ratings impact and utilize their equity currency," said Leo Civitillo, co-head of fixed income capital markets at Morgan Stanley.

THINKING STRATEGY

As equity and loans are increasingly seen as a financing option for M&A, however, CFOs and other corporate leaders have some tricky strategic decisions to make.

US tobacco holding company Reynolds America, for instance, this week announced a US$27.4bn cash-and-stock deal for fellow tobacco giant Lorillard, which was founded in the 18th century.

Reynolds said the acquisition would push revenues to US$11bn and operating income to US$5bn, but analysts were quick to point to the potential impact of any additional debt load.

Moody's immediately said it could downgrade Reynolds's Baa2 rating due to the increased leverage, while GimmeCredit said the acquisition could land the company down in junk-rated status.

Reynolds took out a US$9bn bridge loan - which some expect to be taken out by a longer-term loan - and Carol Levenson, GimmeCredit's director of research, outlined some of the company's potential financing considerations.

"If Reynolds is serious about deleveraging swiftly, then obviously it will want to stagger the maturities of its borrowings and perhaps front-end load these, with at least US$2bn coming due in the first two years," she told IFR.

"The advantage of a term loan versus a bond for this portion of the financing would be the ability to repay it early," Levenson said.

"But the disadvantage is that a term loan would likely have more onerous covenants than straight unsecured investment-grade bonds, thus giving Reynolds less financial flexibility."

Other huge potential deals have also set off ratings alarm bells.

Moody's said AbbVie's plan for a whopping US$52bn cash-and-stock merge with Shire Plc was credit negative, while S&P said Fox could take a ratings hit if its bid for Time Warner went through.

MORE DEALS AHEAD

Even so, the return of volatility in the equity markets means that more M&A deals are ahead on the horizon.

"Equity markets were particularly strong last year, which made it difficult to close deals," said Richard Zogheb, co-head of capital markets origination for the Americas at Citi.

"This year it's getting easier to get deals across the finishing line as we're having more success in getting buyers and sellers to agree on price [because of volatility]."

And with the low-rate environment expected to last, market participants believe the hunger for companies to acquire - or be acquired - will not wane for now.

"Due to the availability of ample capital in the current low-rate environment, there continues to be significant, and increasing, M&A activity in a variety of sectors, including energy and technology, and strategics and financial buyers are attempting to capitalize on these conditions," said Neel Lemon, partner at law firm Baker Botts which advised on 38 transactions of nearly US$57bn in the first half of 2014.

"These conditions were prevalent a year earlier but now the herd is really starting to move." (Reporting by Shankar Ramakrishnan; Editing by Marc Carnegie)