Souring Beer Bonds Expose High-Grade Mania
Investors are increasingly desperate to buy investment-grade corporate bonds, with many viewing them as a good proxy for the highest-rated sovereign debt.
But corporate bonds are different from government notes. They carry specific risks that go beyond just the simple question of whether a company can repay its obligations. A perfect example of this is Anheuser-Busch InBev, which completed the biggest corporate-bond deal on record earlier this year. The beer conglomerate has gone from being a darling of the U.S. credit market to a hot potato in about six months, and it has nothing to do with its revenues or demand for its brew. Rather, investors are worried that the company's planned $100 billion-plus takeover of SABMiller will fall apart, forcing AB InBev to buy back its debt below current market values.
The market response has been fierce. Prices on the company's $81.2 billion of dollar-denominated bonds have fallen 2 percent in less than three weeks, eliminating an estimated $1.6 billion of market value from the debt, according to Bank of America Merrill Lynch index data.
AB InBev's merger with SABMiller may still close. But that's beside the point. Even the mere whiff of trouble has been enough to roil bond markets, suggesting that investors weren't properly prepared as they piled into the corporate debt.
This highlights a growing risk in the $5.5 trillion U.S. investment-grade bond market, which is going through a golden age as central banks globally buy up bonds and keep benchmark rates near or below zero. A record amount of the debt has been funneled toward mergers and acquisitions as companies take advantage of incredibly favorable borrowing conditions. Meanwhile, average prices on investment-grade notes have soared to an average of 109 cents on the dollar.
But some of these deals, many of which were the biggest ever in their respective industries, are starting to fall apart. Companies have terminated more than $820 billion of purchases since the start of 2015, chipping away at last year's record tally. And that can leave bondholders in a tough spot.
Investors were already caught flat-footed when Halliburton's $38 billion merger with Baker Hughes went up in regulatory flames. In November, the company shrugged off mounting doubts about its ability to secure antitrust approval and sold $7.5 billion in bonds to finance the deal. But by April, the deal had fallen apart, forcing the company to buy back a portion of that debt. Bond investors took a hit as a result.
The next trigger point could be Aetna's proposed $37 billion acquisition of Humana. The health insurer has already sold bonds to help pay for this deal, but the Justice Department is throwing a wrinkle in its plans, suing this month to stop the transaction from taking place. Aetna and Humana have a better shot than rivals Cigna and Anthem at getting their deal done, but it's a long shot. And yet Aetna's notes are trading above the 101 cents that the company will have to pay to redeem them should it terminate the merger or fail to complete it on time.
While corporate bonds appeal to a growing number of investors globally because they offer more yield than government notes, they're not the same despite central bank buying sprees. Increasingly this debt is tied to M&A, turning bond buyers into arbitrageurs. This is a fickle market and investors should act accordingly.
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