Reports that some banks have dropped out of the debt financing for the rumored EUR25 billion leveraged buyout of Spanish infrastructure group Abertis (ABE.MC) have underscored why widespread LBO chatter from earlier in the year has hasn't yet reached fever pitch.
LBO talk grew in March but has since diminished with increased market volatility, leaving some market participants speculating there is now more likelihood of strategic mergers and acquisitions.
"The LBO screens keep coming around, and at any given time you have companies that meet the criteria, but there is more wishful thinking than anything," said Marty Fridson, global credit strategist at BNP Paribas Asset Management.
Concern about the mounting debt of some European governments and the potential effect that may have on banks owning that debt have "put a damper on things, so whatever prospects were there were dimmed by the upsurge in sovereign risk concerns," Fridson added.
Financial sponsors are looking at LBO deals, but banks are being pulled in two directions--risk appetite is recovering, with shareholders demanding better returns at the same time regulators are requiring banks to hold more capital against their assets. That means they either have to lend at a slower pace or be more disciplined about putting capital to work, favoring LBOs, where fees are greater, over corporate financing.
Many banks have had trouble tapping debt markets themselves, let alone to finance LBOs, said Olivia Frieser, a BNP credit analyst in London covering European banks. "The market's been very difficult or almost closed for about a month now, so it's not as easy or obvious now," she said.
J.P. Morgan just lowered its forecast for second- and third-quarter U.S. GDP to 3.2% and 3%, respectively, from 4% previously in each case.
A spokesman for Abertis declined to comment, and representatives of each member of the rumored buyout consortium--CVC Capital Partners, Actividades de Construccion y Servicios SA (ACS.MC) and Criteria, the investment arm of the Spanish savings bank La Caixa--didn't return calls. The debt portion of the financing has reportedly been cut to EUR5 billion from EUR8 billion, leaving the sponsors to write a larger equity check.
Fidelity National Information Services (FIS) had been an LBO target, but after those talks broke down, it came to market Tuesday with $1.2 billion in new bonds and got loan to help fund part of a $2.5 billion stock buyback and refinance debt from its acquisition of Metavante Technologies (MV).
While not yet a trend, some point to that as a sign that companies will increasingly find LBO alternatives on their own.
"There were lots of companies wondering after the 2006 and 2007 [LBO boom] why they didn't just lever up and do it themselves," said Adam Cohen, founder of Covenant Review, a research firm focused on corporate bond covenants.
In mid-March, LBO rumors were fueled by pressure on private-equity firms to put cash to work, a narrowing of credit spreads, an increased demand for high-yield debt, and weakening covenants. Existing debt was also trading at depressed prices, so holders were agreeing to participate in tenders and exchanges more readily, said Brian Yelvington, director of fixed-income research at Knight Capital.
At the time, Barclays Capital suggested that possible LBO targets would have had market capitalizations of no more than $7 billion based on equity contributions of 35% to 40% of the total enterprise value and the institutional loan market not being able to digest more than $2.5 billion in new debt. One LBO screen that appeared on financial news website ZeroHedge.com listed 30 unconfirmed targets, and their average market cap was $6.7 billion.
Now the consensus is more like $10 billion, said Cohen, but valuations don't seem to be attractive enough relative to companies' earnings prospects to make LBOs a foregone conclusion.
There have been $80.8 billion in global buyouts this year, according to data provider Dealogic, on par with the $81.4 billion for all of 2009 but far less than the $190.9 billion for 2008. The largest of these was an all-cash bid in May for Extended Stay Hotels, valued at $3.925 billion. Private equity exits in June via trade sales to other strategic buyers or other financial sponsors were the highest since June 2008.
When a company becomes the subject of LBO rumors, traders can profit from the news as the risk premium, or spread, on the acquiring company's bonds widen and the cost to insure its debt increases because of the anticipated increased indebtedness; meanwhile, the target company's spreads tighten.
Risk premiums are the extra return investors demand over super-safe Treasurys to compensate for the additional default risk of corporate debt. The premiums grow as the value of the underlying securities falls.
Examples of this include Kraft Foods Inc.'s (KFT) purchase of Cadbury Plc (CBRY.LN) and the rumored buyout of trash bags maker Pactiv Corp (PAC). Credit default swaps to insure debt issued by Kraft and Cadbury were trading around the same level in late January, around 76 basis points--equivalent to $76,000 per year to insure $10 million, according to CMA DataVision. But spreads on both began to diverge as the acquisition progressed and was confirmed.
Similarly, CDS spreads on Pactiv widened to 301 basis points from 141.6 between May 14 and May 17 after a report in The Wall Street Journal about Apollo Management and other potential acquirers circling the company. Other names on LBO screens are US Cellular (USM), Autozone (AZO), Supervalu (SVU), Lexmark (LXK) and Western Union (WU).
Sponsors may begin to feel more confident about deals with improved macroeconomic data and a better-than-expected second-quarter earnings season. But uncertainty about the global economic recovery and their ability to raise the necessary capital has made it harder to complete deals, at least for now. Even traditional M&A activity has slowed as companies choose a more defensive route of paying down debt.
Some 46% of U.S. high-yield issuance proceeds have been used to repay outstanding debt so far in 2010, compared with 36% in 2009, according to Knight Research. Meanwhile, 19% of issue proceeds have been used to pay down loans, compared with 25% in 2009.
-By Katy Burne, Dow Jones Newswires; 212-416-3084; firstname.lastname@example.org