July 19 (IFR) - As US Treasuries have stabilized and yields
tighten anew, bankers are optimistic that pending M&A trades in
the US high-yield bond market will find strong demand from
investors - and not hurt the underwriters bringing the deals to
Some major LBO and merger & acquisition deals are in the
works, including for US pork giant Smithfield Foods and
industrial machinery maker Gardner Denver, and market
participants are hopeful that the recent bout of volatility that
sent rates surging is under control, and won't have any further
negative impact on the transactions.
Bond underwriters set so-called cap rates on new issues -
effectively, the level beyond a bond's pricing at which they
agree to purchase the remainder of the new bonds that investors
do not buy - and generally give themselves an additional 150bp
to 200bp of cushion when doing so.
But this has proved to be tricky of late because mergers and
acquisitions take much more time to arrange than the simple
selling of debt - meaning that recent and upcoming deals were
planned before the recent surge in rates.
For example, Valeant Pharmaceuticals, the last
large M&A issuer to tap the high-yield market, nearly approached
its cap rate. The USD1.625bn eight-year non-call three senior
unsecured notes tranche, part of the financing for Valeant's
purchase of Bausch and Lomb, priced in late June at 7.5%. This
was heard to have been around just 25bp under its cap in the
high 7% range.
If banks don't syndicate out a new issue and have to price
it at a rate over the cap, they swallow the extra costs. And if
they syndicate out the bridge loan to the buyside, then it's the
investors who suffer if the follow up bond prices over the cap
To avoid getting stuck, bankers have lately been moving up
the cap rates by as much as 200bp. An LBO deal that was expected
to price at 7% with a 9% cap rate, for example, may now come
with a 8.5% or even 9% coupon expectation and a 10.50% or 11%
"Investment banks are going back to the ultimate issuers
with higher caps, so it's up to the issuer to decide how much
they are willing to bear in market risk," said one investor.
While some issuers appear to have decided that's too much -
some would-be borrowers have simply bowed out of recent deals -
others see value in doing deals now before rates, as is widely
anticipated, move still higher in the weeks ahead.
For now, though, at least some cap-tapping fears appear to
have lessened now as the market has tightened back in over 100bp
in the past few weeks, according to the Barclays high-yield
index. And some bankers estimate that upcoming M&A deals have at
least 100bp of cap room available.
"I think we've recaptured most of the losses," said a
high-yield syndicate manager. "There is probably more
selectivity from investors on deals than before, but overall
we've recaptured a lot of the losses and there is less concern
that we are hitting the caps."
Many in the market are paying particular attention to the
upcoming deal from Gardner Denver, which is being seen as the
new bellwether for where LBO risk prices.
The company on Wednesday announced its USD675m bond offering
to partially fund its USD3.9bn LBO by KKR. Expected to price
next week, the eight-year non-call three senior notes, rated
Caa1/B-, were initially being whispered at an unofficial high 8%
The last LBO deal of size in the market was the HJ Heinz
USD3.1bn 7.5-year B1/BB- rated offering that priced at a very
low 4.25% in March, while the McGraw-Hill Global Education
Holdings USD800m B2/BB rated bond offering, also priced in March
as part of its LBO by Apollo, was sold at 9.75% at a discount to
Already, Gardner Denver's USD2.725bn loan, launched last
Tuesday as part of the financing, is over-subscribed, with
pricing being ratcheted lower on Thursday. This could translate
into a lowering of the bond costs as well.
"Gardner Denver will be a good test of the market as to
where to price that kind of risk," said one banker.
Market participants will also look to that deal for signs
that LBO paper can get done at reasonable rates now, which may
encourage issuers to step in sooner than anticipated in order to
avoid the possibility of more volatility in the autumn - when
the Fed is widely expected to begin tapering its bond buying
Indeed, as the tone stabilizes, with the yield-to-worst
falling swiftly back down to 5.89% as of Thursday from a recent
high of 6.97% on June 25 and the yield on the 10-year US
Treasury falling back to a 2.50% range after spiking to a recent
high of 2.75%, some of these deals could possibly be pulled
ahead of Labor Day, market sources speculated.
"If we see Gardner Denver, which is the first LBO out of
this bunch to go, clear in the low 8% range, then I think other
issuers may want to get their deal done sooner instead of
waiting," said a second banker. He added, however, that if an
issuer thinks its deal can still get done within its cap in the
autumn, there is little reason to price it earlier than