DCM 2006 - M&A drives issuance
After five years of corporate deleveraging, M&A activity has returned to Europe with a bang. Acquisition announcements are running close to record highs and corporate bankers are eagerly awaiting a flood of bond issuance. However, although the M&A revival will certainly result in increased corporate bond issuance, it is unlikely to have any significant impact on volumes until next year, as Helen Bartholomew reports.
The European credit markets appear to have reached an inflexion point, with the deleveraging trend finally running its course as corporates turn their focus to shareholder incentives in an effort to boost earnings against the expectation of a weakening economic backdrop. Balance sheets have largely been repaired, and with many corporates sitting on large cash reserves, M&A has returned to the top of the agenda and is expected to be the trigger that could make all the difference to corporate new issue volumes.
M&A activity is currently running at the highest level since 2000. In Europe, the total volume of M&A transactions announced in the first quarter of 2006 involving European companies amounts to US$443bn equivalent, which is more than double the figure seen in the same period of 2005. In addition, the average size of acquisition targets is on the increase with the total number of announcements actually 13% down on last year.
With big ticket M&A back on the agenda, primary bond markets are poised for a deluge of refinancing activity from European corporates. The first quarter of 2006 has already seen an increase in euro corporate bond issuance, with more than €40bn of paper issued, compared with just €33bn for the first quarter of 2005. Some of that increase has come on the back of M&A financing, but bankers are not expecting to see the full effect of the M&A hike until next year given the lead time between an initial announcement and eventual bond take-out.
"The large M&A volumes we have seen this year will eventually translate into bond deals as part of the refinancing package, but there is a lead time between the initial announcement, the deal closing, putting the bridge financing in place and the eventual refinancing. In the best case scenario it can take place within six months, but typically it is often more a question of 12 to 18-months," said Arnaud Achour, head of DCM origination at SG.
The consensus among traditionally optimistic corporate bankers is that total volume for the year ahead will see little increase on 2005 volumes. "M&A activity should push issuance volumes slightly higher in 2006, and there should be an dramatic increase in corporate issuance next year. But away from M&A, corporates have got limited financing needs, as much liability management has already been addressed and the refinancing requirement has been reduced," said Fred Zorzi, co-head of European syndicate at BNP Paribas.
In reality, there has been very little direct M&A-related bond issuance so far this year. Telefonica provides the main example of an issuer that has already begun its bridge take-out in the bond market. The issuer announced late last year that it would consider all financing opportunities other than equity to refinance its €27bn takeover of UK mobile operator O2, and that a large portion of that would be done in the bond markets. In mid-January, the issuer made its first steps in refinancing the bridge loan through the euro bond market, and also made its inaugural trip to the sterling market. The second wave of its refinancing strategy should see the issuer make an inaugural visit to the US dollar market, which is likely to be followed by a subordinated hybrid bond.
A number of other large refinancing trades are on the cards, with the largest of Europe's M&A announcements so far including E.On's US$57bn bid for Endesa, Suez's US$45bn merger with Gaz de France and Mittal Steel's US$24bn bid for Arcelor. Other multi-billion dollar transactions include Grupo Ferrovial's US$21bn bid for UK airports operator BAA, Bayer's €16.3bn bid for Schering, National Grid's US$12bn takeover of US utility Keyspan, and Linde's £8bn bid for UK gasses group BOC.
Although the current M&A wave is likely to result in some chunky bond transactions, bankers believe that corporates will take an increasingly piecemeal approach to refinancing, with the large €2bn plus sized bond issues becoming increasingly rare following the recent wave of liability management that has seen corporates attempt to smooth their previously lumpy redemption calendars. Telefonica, for example, split the first €5.8bn leg of its refinancing into four separate tranches in euros and sterling. For corporate issuers, multi-currency transactions are becoming increasingly attractive in generating price tension, diversifying the investor base and opening up the full range of maturities, particularly since euro investors turned their backs on long-dated paper in the early part of 2006.
"Last year there was a market for 15-year to 20-year issues in euros but this year issuers are looking at the sterling market to access the longer end of the curve as it is the natural home of longer maturities and the credit curve remains quite flat compared to the euro curve," said BNPP's Zorzi.
Hybrids to the fore
Corporates finally began to embrace subordinated hybrid bonds last year, as almost €7bn of issuance flowed into the market. The main driver has been the rating agencies' clarification on the treatment of the instruments, but this year, bankers are expecting to see the product gain prominence as an M&A financing tool. So far, much of the activity that has happened has been related to M&A situations. For example, Vattenfall's €1bn perpetual non-call 10 was intended to raise pseudo equity capital to finance bolt-on acquisitions, while Dong's €1.1bn 1000-year non-call 10 issue was used to refinance a range of acquisitions that it had already made. Bankers believe that the M&A wave will further cement the importance of subordinated bonds as a corporate financing tool.
"Corporates, whilst acknowledging the benefits of hybrid capital, are reluctant to issue unless they have a very clear use of proceeds given the high cost of carry implications. But for a corporate with a bolt-on M&A strategy, which is running to the limit on its ratings targets, a hybrid makes a lot of sense," said Malcolm Cruickshanks of JPMorgan's European hybrid capital team.
M&A situations have already proved to be the primary rationale for hybrid issuance in 2006 with Vinci raising €500m through its perpetual non-call 10 issue following its €9.1bn acquisition of Autoroutes du Sud de la France (ASF). Although the hybrid did not form part of the official financing package for that acquisition, it was intended to support the issuer's ratings after taking on a €6.5bn loan to finance the purchase. Italian lottery company Lottomatica is planning a €750m hybrid as part of its €4bn acquisition of gaming technology company GTECH, and there are more in the pipeline. German gasses group Linde is planning to issue up to €1.6bn of hybrid bonds to finance its acquisition of BOC while Bayer is considering a second visit to the market as part of the financing for its acquisition of Schering, and Telefonica is still considering hybrids as part of its O2 acquisition package.
"A hybrid is now considered systematically for any issuer with substantial acquisition financing needs and compatible credit story. For bankers, issuers and investors, the consensus is to get fair deals priced. The fact that a large portion of the corporate hybrid market is not just opportunistic, but will form part of a refinancing package on the back of an acquisition, should help to ensure that this product is handled sensibly with a clean execution and a smooth aftermarket," said Jean-Francois Mazaud, head of corporate DCM origination at SG.
While bankers welcome the increased volumes that should stem from the M&A wave, the return of acquisition activity has not come without its downside for the credit markets, given the havoc that LBO rumours have been creating on single-name credit spreads. BAA felt the full effect of the LBO threat when Grupo Ferrovial's initial approach forced the issuer to push last-minute change of control language into its new bond documentation after spreads ballooned ahead of settlement. For an increasing number corporate issuers, change of control clauses have become a requirement for a successful bond transaction after the bid for BAA proved that spotting LBO candidates is a difficult to impossible job.
Some issuers such as BAT and Tesco have proved that it is possible for some names to get bonds away without takeover protection, but they are increasingly few and far between. And as LBO fears become heightened, investors are chasing improved protection language. In mid-March, Swiss pharmaceutical company Clariant took the change of control debate one step further with more investor-friendly language that allows the bonds to be put at a spread over Bunds rather than at par in the event of a takeover that pushes the issuer into junk territory. For the time being, investors have taken the driving seat in the corporate new issue market, and with a hefty issuance calendar ahead, they could remain there for the foreseeable future.