NEW YORK (IFR) - While bankers were lamenting the collapse of US$88bn in healthcare mergers this week, markets were surprisingly upbeat about the latest upheaval in the sector.
Insurance giant Aetna finally threw in the towel on Tuesday when it terminated its US$34bn merger attempt with rival Humana after US courts ruled against the deal earlier this year.
Cigna also announced the same day that it was seeking to end Anthem’s US$54bn bid for the company, unleashing a bitter court battle between the two sides – and potentially dragging advisers into the scrap.
Aetna – which unlike Anthem pre-funded its acquisition in the bond market – can use debt proceeds to cover the cost of cancelling its merger.
Anthem, on the other hand, may still prefer to tap the bond market to pay for its US$1.85bn termination fee rather than stop share repurchases or dividend payments, said Josh Esterov, a senior analyst at research firm CreditSights.
Special mandatory redemption clauses (or SMRs) oblige Aetna to buy back US$10.2bn of bonds at a cash price of 101.
All six securities were part of a US$13bn eight-part bond sale in early June to finance the Humana acquisition.
It also owes Humana US$1bn in termination fees, as well as close to US$90m in accrued interest, according to CreditSights.
The debt buyback and the termination fees are expected to be funded through proceeds garnered during June’s bond sale.
The buyside, however, cheered the outcome, pushing spreads on Aetna bonds tighter over last week amid expectations that the deal was on its last legs.
“They will call a substantial portion of the US$13bn they issued in June, and will not assume Humana’s outstanding debt,” said Esterov. “That part is credit-positive.”
Esterov calculates that Aetna’s debt-to-Ebit ratio over the past 12 months should drop to around 2.3 times from 4.5 times.
Aetna’s latest bonds also rarely traded far above the 101 redemption price, leaving accounts with fewer losses than other failed M&A bonds whose secondary levels peaked several points higher than where they were ultimately called.
“In other deals [involving a merger break-up] this could have been a major issue, but investors knew in advance that the deal faced anti-trust issues,” said Esterov.
“Aetna bonds didn’t go too far ahead of 101, and when you take into account coupon payments, they stayed in a rational price area.”
Not only did long-held doubts about the Aetna/Humana tie-up keep prices at or below the redemption price, but a US Treasury sell-off after Donald Trump’s electoral victory in November also pressured corporate bond prices lower.
“Last year [when Aetna priced the bond] you had to ask if the deal didn’t go through would we be taken out at 101,” said a buyside trader.
“All that went into reverse after Trump won and rates sky-rocketed and those Aetna bonds hung around par. That benefited investors.”
Still, this week’s break-ups – the first major ones in 2017 – have renewed the focus on how best to structure and time M&A-driven bond sales amid expectations that political and regulatory scrutiny will put more jumbo tie-ups at risk.
“This will only reinforce the fact that borrowers probably need to align their financings to when it is more probable that transactions will close,” said a senior banker.
Investors are asking to be better compensated for such risks or at least want to limit potential losses in the event that the courts or regulators strike down proposed tie-ups.
“These pose new risks that are not always easy to assess when you are trying to figure out what the Department of Justice or the courts might do,” said Chris Gootkind, director of credit research at Loomis Sayles.
Market participants continue to debate whether the SMRs should be higher than 101, or indeed whether redemptions should be linked just to price.
Some are advocating a structure more akin to a make-whole call that is tied to a US Treasury spread, though some bankers think getting borrowers on board will be tough.
“You are asking the borrowers to accept all that rate risk between the timing of the bond issue and the timing of the settlement [of the M&A transaction],” said the senior banker.
“If I were a borrower I would push back.”
That, though, may be less true at a time when the Federal Reserve is looking to further tighten monetary policy as markets bet on some fiscal stimulus from the new Trump government.
“There are more opportunities [to include a make-whole call] in a rising rate environment as it will protect the issuer if bonds fall in price,” said Gregory Nassour, co-head of investment grade credit at Vanguard.
Reporting By Paul Kilby; Editing by Shankar Ramakrishnan and Matthew Davies