Two large acquisition financings from Merck and Ecolab led a crowded investment-grade primary market this week, helping to set a new record for high-grade bond supply in the month of December.
As of Tuesday, investment-grade corporate bond issuance this month hit US$57bn, surpassing the US$56bn of supply recorded in the December of 2014, according to IFR calculations.
Execution for the M&A-driven jumbo offerings was strong, suggesting demand had recovered since the end of November. Market participants had been wary of participating in the primary market after some bond offerings priced before the Thanksgiving holidays traded poorly on the break.
Easing concerns around the Omicron variant's economic impact this week helped restore risk appetite, reversing some of the widening in credit spreads in November. The average IG spread was at 100bp over Treasuries, after climbing to a March high of 104bp on December 2, according to ICE BofA data.
Pharmaceutical Merck sold on Tuesday a US$8bn five-part senior unsecured note to support its US$11.5bn purchase of another pharmaceutical company Acceleron, drawing US$32bn of orders. New issue concessions ranged between 2bp to 3bp for the tranches.
For its acquisition of resin maker Purolite, water treatment specialist Ecolab raised a US$2.5bn bond on Monday, backed by an order book of US$8.25bn.
Market participants had been anticipating some large acquisition financing packages to hit the US primary market.
Banks were under pressure to bring any M&A bonds before the end of the year to avoid having to carry risk on their balance sheets through the turn of the year. And market volatility in late November made it tricky to clear the decks before December got underway.
“Banks taper [their balance sheet] before going into year-end so there’s [typically] not a lot of supply in general sloshing around,” said Adam Coons, portfolio manager at Winthrop Capital Management.
M&A
The improvement in corporate balance sheets and earnings throughout this year have meant investors have been more forgiving of debt-financed M&A, especially for companies with a history of whittling down a buildup in leverage from a chunky acquisition.
“M&A bond issues can go well. But management has got to have credibility. They’ve got to show they’ve cleaned up their balance sheet before,” said a senior credit analyst.
Indeed, Ecolab underlined its commitment to cut down on its debt following its purchase of Purolite, which is expected to lift net leverage to 3.2 times from 2 times, according to CreditSights. The company said it would divert cash to pay down incoming short-term maturities, based on an investor presentation.
In the end, the willingness of investors to absorb these large M&A bonds came down to the vibrancy of primary markets and cheap borrowing costs. Even after corporate debt levels swelled from the purchase of a new business, their overall cost of servicing the debt may not have risen much as they were issuing new bonds when Treasury yields remained historically low and credit traded at tight spreads.
"The actual debt service is getting better even as leverage is ticking up," said Coons. “It’s easier to manage debt loads when capital markets are wide open. We joke that you could probably issue debt at a lemonade stand right now."