ETF News

US CREDIT-LBO risk returns as demand for yield rises

 NEW YORK, March 18 (Reuters) - Some U.S. companies are
likely to see debt costs become more volatile as improving
demand for risky debt and increasing merger and acquisition
activity bring back the specter of leveraged buyouts.
 SuperValu SVU.N and RadioShack RSH.N are among
companies that have seen their credit default swap costs jump
in recent weeks on rumors that they may be targeted in an LBO.
 Private equity companies have also announced a number of
acquisitions in recent weeks, including Bain Capital Partners
purchasing Dow Chemical Co's Styron basic plastics unit and
Thomas H. Lee Partners [THL.UL] buying CKE Restaurants
 "We think the trend of the market refocusing on LBOs is
clear and likely to persist for some time," Barclays
technology, media and telecom analysts Hale Holden and Danish
Agboatwala said in a report.
 LBOs typically involve private equity firms using debt to
purchase a company, which often causes high grade companies to
fall into junk territory and sends their funding costs
significantly higher.
 Companies can also use debt to fund acquisitions of
competitors, such as in Phillips-Van Heusen's PVH.N recent
agreement to acquire of Tommy Hilfiger. In many cases this
hurts their credit profile, in spite of other gains made from
the acquisition.
 LBOs were popular in the low cost credit markets from 2005
to 2007, when many companies also able to undertake deals using
debt with few restrictive terms. The cost and availability of
credit has contracted significantly since then, especially for
riskier companies; however a recent recovery in the credit
markets suggests terms may be beginning to loosen.
 "Demand for high yield debt has been strong in the past few
weeks and if it remains robust there could be a grab for higher
yield, which can lead to higher leverage levels and weaker
covenants," said Brian Yelvington, fixed-income analyst at
Knight Libertas in Greenwich, Connecticut.
 "If the CLO market were to open up that would provide the
availability for more leveraged acquisitions," he added.
Though, "you would probably need some larger firms being
acquired with leverage before it becomes a focus for the market
as it was in 2005-07."
 CLOs, or Collateralized Loan Obligations, are structured
deals that package loans and demand for the vehicles provided
for much of the credit that was extended during the last LBO
boom. Citigroup is arranging a deal in which the size of a CLO
will be increased, indicating improving demand for the
vehicles, Reuters Loan Pricing Corp reported last week.
 An uptick in mergers and acquisitions also suggests that
more companies may turn to the debt markets to acquire their
smaller competitors.
 Larger companies have greater ability to cut expenses than
smaller firms, which can be key to maintaining earnings in a
weak economic environments.
 "I believe the trend in improving operating margins via
cost cutting will continue in 2010 in order for companies to
meet earnings targets," said Knight's Yelvington.
 M&A activity year-to-date has grown to $177 billion, its
highest level since 2007 when $352 billion in deals were
announced in the same period, according to Thomson Reuters
 Barclays said it views LBOs on investment grade companies
in the TMT space as unlikely in the near term as rallying
equity markets have made most companies too large to finance in
the debt markets.
 Nonetheless, "private equity pressure will be felt
indirectly, through both increasing prices of M&A targets and
placing pressure on management teams to accelerate share
repurchases and/or dividends," they said.
 This pressure will be particularly acute on companies whose
stocks have underperformed broad or peer sector indexes, they
 Barclays views Pitney Bowes PBI.N, Expedia EXPE.O, RR
Donnelley RRD.O, H&R Block HRB.N and Computer Sciences
CSC.N as being at risk of LBO speculation due to their
smaller size and underperforming equity, even if the companies
are unlikely to be acquired in any deal.