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The value of leveraged loans that changed hands fell last year, but a close look shows other measures of liquidity improved.
February 11
The M&A explosion in the broader business world has a fringe benefit for banks.
The recent spate of large mergers and buyouts promises to bring billions of dollars in new issues of leveraged loans and high yield bonds. Big banks are the source of many of these commercial loans, and they often syndicate them to institutional investors. These loans trade in the secondary market, too.
Market participants expect a steady flow of mergers and acquisitions throughout the year with increasing participation from private-equity firms. However, investors say that the market is not likely to approach the excesses of the 2007 buyout boom anytime soon.
Several big-ticket buyouts and mergers have already brought billions in new deals to the junk bond and leveraged loan forward calendars.
Virgin Media sold $3.7 billion in a four-part, dual-currency high yield bond deal on Feb. 7 that will help finance its $23.3 billion acquisition by Liberty Global. It also recently obtained $4.7 billion in loans to help finance the deal. The loan package includes a $2.76 billion term loan due in 2020 and a $939 million term loan due in 2020. Credit Suisse (CS) was the lead arranger.
Computer manufacturer Dell announced on Feb. 5 a $15 billion covenant-lite credit facility to fund its $24.5 billion going-private transaction led by Silver Lake Management and company founder Michael Dell. Lead managers for the loan package are Bank of America's (BAC) Merrill Lynch unit, Barclays (BCS), Credit Suisse and RBC Capital Markets (RY). The company is expected to offer $2 billion in first-lien notes and $1.25 billion in second-lien notes on the high yield market. The buyout faces serious opposition from leading outside shareholders, however.
The latest deal that could add billions to both market is the $28 billion purchase of H.J. Heinz Co. by Warren Buffett's Berkshire Hathaway (BRK/A) and Jorge Paulo Lemann's 3G Capital. JPMorgan Chase (JPM) and Wells Fargo (WFC) have agreed to provide $14.1 billion of financing for the buyout, which is expected to close in the third quarter.
The debt comprises first- and second-lien dollar-denominated term loans totaling $8.5 billion; first- and second-lien term loans denominated in euros and British pounds totaling $2 billion; a $1.5 billion revolver; and a $2.1 billion second-lien bridge loan facility. Given past deals, it is likely that the company will take out the bridge loan facility with new junk bonds.
The Heinz deal will be an easier sell to credit investors than the Dell deal, according to Eric Green, senior portfolio managers and director of research for Penn Capital Management. "Heinz would be a really good credit on the high yield side," Green said. "Dell is in a business that isn't well understood on the high yield market … and that deal would probably have to come at a higher yield. Heinz, that's an easy business to get a handle on from a credit standpoint."
People active in the credit markets say that a deal wave was inevitable.
"A lot of the pieces have come together," said Michael Collins, a portfolio manager and strategist with Prudential Fixed Income. "You have cheap financing costs on the debt side, moderate or low equity valuations and a lot of liquidity in the system, i.e. lots of cash looking for a home. And you have a challenging growth environment."
Mergers and acquisitions in the broader business world are the most convenient way for corporate issuers to stay competitive or gain market share, Collins says.
"A lot of the M&A ... is companies trying to improve their bottom line," Collins says. "The airlines are a great example of that."
The stock-for-stock merger of American Airlines parent AMR Corp. with US Airways is valued at $11 billion. It will give AMR's creditors 72% of the new company and US Airways shareholders will control the remaining 28%. AMR declared bankruptcy in November 2011. The companies expect 2015 annual synergies of more than $1 billion.
"I expect M&A to be very, very strong this year," Green said. "The last ingredient we needed was a stable equity market and a level of certainty on some of the big issues such as the fiscal cliff. Those issues are by no means resolved, but we know more than we did three months ago or six months ago. Conditions are better than they were last year in that respect, and last year was a very good year for deals."
Moreover, the effects on the credit markets will be positive, beyond the added deal flow, market participants say. "The M&A effect will be positive for the leveraged loan and high yield bond markets," Lorenzo Newsome, co-chief investment officer with NCM Capital, said.
"The number of' 'rising stars' should increase with acquisitions from higher-rated issuers. With high yield indices yielding around 6%, focusing on issuers that can provide upside by being a potential M&A target can substantially boost total returns," Newsome said.
But unlike the large buyout boom of the 2006 and 2007 era, few expect the levels of leverage and risk to accompany this current boom in mergers and acquisitions. Market participants expect greater levels of private equity participation as the year progresses, though big-ticket deals like the Dell transaction will be rarities.
"We're a long way from that part of the cycle where leverage is really picking up," Collins said. "We're still a couple of years away from a serious deterioration in the high yield market. Ultimately that could happen at some point in this cycle. This is the first salvo."
Mike Simonton, managing director and head of U.S. leveraged finance with Fitch Ratings, agreed. "Right now we're seeing higher quality companies being purchased at reasonable transaction multiples and being funded with a relatively prudent mix of debt and equity. ... We'd be more concerned if deal volume increased dramatically, enterprise value and leverage multiples become excessive and the quality of companies being leveraged were to deteriorate materially."
