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 and RadioShack 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 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 data.
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 said.
Barclays views Pitney Bowes , Expedia , RR Donnelley , H&R Block and Computer Sciences 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.
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