M&A boom, bondholder doom

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The balance-sheet re-leveraging involved in big M&A deals threatens companies’ credit standings and thus their bondholders’ paper.

The spurt in big-ticket mergers and acquisitions might symbolize a welcome return of confidence, but for bond investors it means that event risk is a growing concern.

Over $160 billion of M&A has been announced globally since the start of the year – the fastest and most impressive start to a year since 2005, according to Dealogic.

But rising chief executive confidence, record low debt costs and an equity market eager for companies to spend make for a bad cocktail for bondholders.

This is because of the impact balance-sheet re-leveraging can have on the credit standing and financial health of companies, whether acquirer or target.

Take the $28 billion buyout of Heinz by Warren Buffett’s Berkshire Hathaway and Brazilian private equity firm 3G Capital. The Sage of Omaha’s involvement is usually positive for his target companies, but on this occasion the effect on Heinz’s credit standing has been the complete opposite.

On news of the deal Heinz’s credit default swaps blew out by 116 basis points to trade at 160bp, comfortably exceeding the previous record level in December 2008.

Strikingly, Heinz’s CDS spreads widened far beyond Berkshire Hathaway’s CDS, which were steady at around 100bp, according to Markit.

The reason? Berkshire Hathaway is putting up around $12 billion to $13 billion of the buyout outlay; the remainder is being provided by 3G Capital and will comprise a combination of cash, rollover of existing debt and, of course, new debt financing, together totalling about $12 billion.

Heinz was a very strong investment-grade-rated credit with a robust balance sheet. That may change.

Since the deal was unveiled, Moody’s and Standard & Poor’s have been reviewing their respective Baa2/BBB+ ratings with a view to a possible downgrade, while Fitch Ratings has already junked Heinz – cutting its rating three notches from BBB+ to BB+.

Bondholders in computer maker Dell, which is being taken private by its founder, Michael Dell, and private equity firm Silver Lake Partners in a $24.4 billion buyout, should also be concerned.

The deal will be financed through a combination of cash and equity contributed by Michael Dell and Silver Lake, with an additional $15 billion in debt funding from banks, and a $2 billion loan from Microsoft. Fitch and Moody’s have already downgraded the company to BB+/Baa1 respectively and might cut further. S&P rates Dell A- for now.

Given the size of both buyouts, "all of a sudden the theory that the next LBO cycle will have more restrained and manageable deal size with less HG bondholder damage [than was seen in 2005-07] will be justifiably questioned," says Glenn Reynolds of CreditSights.

Investors are already asking questions such as "Who is next?" and "How bad can this get?" This nervousness is being reflected in the credit markets.

News that two private equity consortiums are hunting UK mobile operator Everything Everywhere has increased LBO concerns, and pushed spreads wider on companies such as Kingfisher, J Sainsbury, Wolters Kluwer, Wm Morrison Supermarkets, Marks & Spencer and Rentokil.

Beware. Event risk is back with a bang.