Companies tapping bond market as first choice for M&A
Mergers and acquisitions have undergone a paradigm shift as far as some are concerned, with bond issuance fast becoming the default funding source, but others say bank lending can still give debt a run for the money.
The change is being driven on the part of corporates by the reduced availability of funding from banks, and by investors in their never-ending search for yield in an environment where low-risk returns are at all time lows. With regulation constricting banks’ capacity to carry longer-term loans, corporates are being forced to look for other sources of capital to fund their strategic growth plans.
Martin Bartlam, partner at DLA Piper, says as bank balance sheets come under pressure because of Basel III and other regulatory restrictions, their ability to expand assets is reduced and the market looks for alternative support for funding.
“We’re seeing a marked increase in the high-yield bond market because there are a lot of players taking advantage of relatively lower cost of funds,” he says. “But whether it’s high-yield, investment-grade, or structured secured bonds, it’s a permanent change.”
If Basel III has the anticipated long-term effect of requiring higher levels of capital in all credit institutions, it will necessarily mean less lending available, or lending available at higher cost, says Bartlam.
“At a time like now, when there’s not a lot of investments around that are giving investors good yields, if an investor can find an investment where it thinks there’s a good business but paying a relatively high yield, it’s a good opportunity for it,” he says.
“There’s demand on the investor side and there’s the potential for the issuers if they can find good businesses – there is some appetite on the high-yield area.”
Bartlam stresses that banks will continue to play a vital intermediation role, but that role is likely to be more one of providing short-term flexibility in getting corporates to a position where they can raise long-term committed funding in the debt capital markets.
Global M&A activity is slightly up on last year, with deals totalling $947 billion in the year-to-date compared with $889 billion in the same period last year, according to data from Dealogic in London.
However, the deals that are going through are much larger this year when compared with the same period in 2012, signalling increased appetite for the blockbuster deals of the past.
More of these acquisitions are being funded through bond-issuance deals that are increasing in size relative to loans. In 2012, M&A-related bond issuance was $201 billion, up from $147 billion in 2011, with the average deal topping the $1 billion mark.
Issuance this year is keeping pace, with North America dominating the action.
Big-name deals funded in part by bond issues this past 12 months include Liberty Global’s $24.1 billion acquisition of Virgin Media and Heineken’s $4.5 billion takeover of Asia Pacific Breweries.
In February, Freeport-McMoRan Copper & Gold raised $6.5 billion towards a $6.9 billion cash and stock bid for Plains Exploration and a $3.5 billion bid for Freeport-McMoRan Exploration through an investment-grade bond issue.
Heinz and General Motors raised $3.1 billion and $2.5 billion in March and May respectively.
SoftBank Corp of Japan and Dish Network Corp, which are vying to take over Sprint Nextel, have sold $3.3 billion and $2.5 billion of bonds respectively to help fund the cash portions of their bids.
Most of these deals were high-yield corporate bond issues. Dish Network employed the common tactic of leveraging the bond deal to tap the banks, arranging it for loans as part of its effort to outbid SoftBank. Virgin Media successfully used the same strategy to raise a $4.7 billion loan.
The figures appear to show that loans-to-fund acquisitions still far outstrip bond issuance. However, the data include all loans arranged, whether or not they are utilized.
Loans might precede debt capital fund raising to have funds in place before making a bid. The loan is repaid immediately after bond funding, or, if the bid is unsuccessful, the loan is not drawn.
“Some of the difficulty here is just economics,” says Martin O’Donovan, deputy policy and technical director of the Association of Corporate Treasurers. “It is surprising what banks can still do if they have to. They are still willing to do pretty hefty-sized deals, but the balance may just be moving slightly away from loans.
“The beauty of a borrowing facility from a bank is that it can sit undrawn and be called upon at a moment’s notice. In the bond market you’ve got to draw down the money pretty much on day one, which necessarily means it has to be arranged ahead of time.”
O’Donovan says one of the reasons companies are holding substantially more cash on their balance sheets than in the past is that they have tended to fund themselves with a bond and put the money on deposit until it is needed.
However, he warns it is highly inefficient to borrow at 4% or 5% and then put it on deposit a week at a time at 0.5% until the funds are required.
“There’s a huge cost of carrying of pre-funding something, but if a company wants certainty that’s one way of doing it,” says O’Donovan.
Even though bond investors are willing to invest in good companies, they would be wary of a company borrowing for purposes not yet specified.
“An investor doesn’t want to lend to a company and then discover they’ve used the money to completely turn the company into a different business; different credit risk,” says O’Donovan.