A spate of recent mega mergers and acquisitions(M&A)
appear to be spurred at least partly by the availability of cheap
corporate credit. Deals are also driven by the estimated $1
trillion in cash holdings of large companies. Keep in mind that
private equity firms reportedly hold an estimated $190 billion or
so of unexpended capital which they are eager to deploy. Among
negative industry trends, private equity players are finding it
tough to sell out and as a result, they are buying and selling
portfolio holdings among themselves (tertiary buyouts).
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Berkshire Hathaway Inc.
) together with Brazilian private equity outfit 3G Capital is on
its way to taking over all 56 varieties of iconic
H. J. Heinz Company
) in a $23 billion deal. In a $24 billion transaction, the
) is de-listing the company with help from private equity firm
Silver Lake partners and
), who will be minority partners.
) bid almost $17 billion for the 49% remainder of NBC Universal
still owned by
General Electric Company
). The all-stock merger of
AMR Corporation (
US Airways Group, Inc.
will create the largest airline in the world with a market cap of
Anheuser-Busch InBev SA/NV
) re-submitted a $20 billion offer for the acquisition of Mexican
brewer Grupo Modelo, of Corona fame. Finally, there is John
Liberty Global Inc. (
's takeover of British cable company Virgin Media for about $15
billion in a cash-cum-stock deal.
Due to contributions from Michael Dell and the company's
substantial cash holdings, Dell will not be as heavily leveraged,
post buy-out, as assumed earlier. A consortium of banks,
Bank of America Corporation
) and RBC Capital among others, revealed a credit program of
about $14 to $15 billion.
Fitch Ratings cut Heinz's credit rating to junk status as
Wells Fargo & Company
JPMorgan Chase & Co.
) unveiled a $14.1 billion borrowing program for the company.
Heinz and Dell, along with other marquee deals, will increase the
supply of high yield bonds (a k a junk bond) in the market.
Companies with investment grade credit quality are also
increasingly turning to the corporate bond market for financing.
) recently engaged in huge multi-billion dollar borrowings at
super-low yields to fund share buyback or other requirements.
More companies appear to be skewing their capital structures in
favor of debt while maintaining favorable debt service coverage
Among supply side issues, high yield bond issuance hit a record
last year and the robustness continues. Fund raising companies
frequently used the proceeds to refinance higher interest-bearing
loans. Then high yield bonds are increasingly being issued by
private equity firms to fund their acquisitions. In any case,
there is no doubt that the boom in high yield bonds has ensured
access to financial markets for even those companies with the
lowest credit quality.
On the demand side, corporate bonds are not just attractive to
retail investors. They are also favored by institutional
investors, such as insurance companies. In 2012, very low
interest rates continued to force yield-starved investors to
shift from the safety of Treasuries to more risky assets, such as
high yield bonds. The interest in high yield bond funds was so
great that some mutual funds, such as T. Rowe Price, even refused
to take new investors. Fueled by robust demand, high yield bond
yields breached crucial levels and roosted at sub-6% levels late
last year. The decline in high yield bond yields noticeably
reduced the charges for leveraged buyouts.
Subsequently, the tide changed course in early 2013 such that
iShares iBoxx $ High Yield Corporate Bd
) faced redemption pressure for three or four weeks in a row.
Consequently, high yield bond fund yields were temporarily back
above the 6% mark. Despite the recent minor correction in high
yield bond prices, bonds are still 'priced to perfection' with a
yield to maturity that compares unfavorably with the earnings
yield (inverse P/E) of the benchmark S&P 500.
Currently then, high yield bond yields translate into 400 to 500
basis points spread over comparable U.S. Treasury bonds. The risk
premium today is on the lower side but not at its nadir. Market
mavens still believe that there may be room for shrinkage of the
This bullish outlook is supported by the low default rate for
high yield bonds at about 3.2% recently versus the long-term
track record of 4.5% or so. The outlook for the default rate is
favorable in the medium term although there is some divergence of
opinion between Standard & Poor's Ratings Services - a unit
The McGraw-Hill Companies, Inc.
) about its future course. There are some signs of credit
degradation with the proportion of credit hikes to credit
downgrades turning negative recently.
As for deal-making capability, JPMorgan Chase & Co. is the
numero uno among M&A arrangers and
The Goldman Sachs Group, Inc.
) as another leader. Investment bankers have seen their fortunes
soar in line with the growing appetite for high yield bonds,
which provides a point of cheer in a season of layoffs on Wall
Street. JPMorgan Chase & Co. and
Deutsche Bank AG
) are just two investment banking boutiques whose high yield arms
have done well.