Loan-Market Slump Threatens to Gum Up Wall Street's M&A Machineby
Almost half of $75 billion LBO debt trades below issue price
That's not for good companies that still need buyout funding
Here’s an ominous sign for Wall Street’s debt-fueled M&A bonanza: Investors are increasingly wary of loans that fund leveraged takeovers.
Almost half of the $75 billion buyout loans arranged in the U.S. last year and tracked by Bloomberg in the secondary market are trading below their issue price.
That includes a $2.5 billion loan that backed Blackstone Group LP’s purchase of industrial-products maker Gates Corp. and a $1.4 billion loan that helped finance Charterhouse Capital Partners’s acquisition of e-learning firm Skillsoft. In just six months, Gates’s loans have dropped to 94.4 cents on the dollar from 100.5 cents. Skillsoft’s debt has plunged from above par in April to about 86 cents.
That’s making the job tougher for banks that need to arrange more than $66 billion of funding to finance buyouts and mergers. Underwriters are already being forced to sell the debt at the steepest discounts in four years and now investors are pushing for higher interest rates as well to help offset the declines in loan prices. That doesn’t bode well for companies like Western Digital Corp., which expects to raise $18.4 billion of debt for its purchase of SanDisk Corp., and for Dell Inc., which may need almost $50 billion in loans and bonds to fund its takeover of EMC Corp.
“If you’ve got something the market doesn’t like, it’s going to take a lot to get it to move,” said Mark Okada chief investment officer at Dallas-based Highland Capital Management, which invests in high-yield credit. “If you’re out of our risk box, we aren’t going to touch it.”
Of the 195 dollar-denominated buyout loans issued last year that have secondary market prices tracked by Bloomberg, 94 are trading below their issue price. Leveraged loans may be headed for their first loss since 2008 as a rout in commodities and a slowdown in China wipes out gains in speculative-grade debt.
“Until the market settles down, and one or two regular opportunistic deals come, issuers tend to want to sit on the sidelines” said Tim Broadbent, the New York-based head of Americas leveraged loan syndicate at Barclays Plc. “The market is pretty selective on credit.”
That hasn’t slowed down dealmaking. SolarWinds Inc., a maker of software for managing computer networks, said Wednesday it agreed to be bought by private-equity firms Silver Lake Partners and Thoma Bravo in a $4.5 billion deal. The buyout, which is expected to close in the first quarter of next year, will further test the market’s appetite for high-yield credit.
Loans are losing favor, with investors pulling cash for 12 straight weeks from mutual funds that invest in the debt. Collateralized loan obligations, the biggest buyers of the debt, are also backing away, with only $5.8 billion of the funds created last month, according to data tracked by Bloomberg. That’s 34 percent below this year’s monthly average and the least since May.
Fullbeauty Brands LP, an apparel retailer for plus-sized people, sold a portion of a $1.2 billion loan backing its buyout by Apax Partners for as little as 87 cents on the dollar after struggling to attract investors, according to data compiled by Bloomberg. Other large discounts were offered this month on loans for Canadian pharmaceutical company Concordia Healthcare Corp. and Houston-based software provider Idera Inc.
Concordia sold a $1.1 billion term loan backing its purchase of drugmaker Amdipharm Mercury Ltd. at 94.5 cents on the dollar after failing to unload the debt at 99 cents, Bloomberg data show. Idera issued $400 million of loans financing its acquisition of Embarcadero at 90 cents on the dollar, the data show.
Eaton Vance Corp., which oversees $35.5 billion of loans, is steering away from middle-market borrowers as well as deals that aggressively load up on debt, according to institutional portfolio manager Christopher Remington. “Heading into the later innings of the credit cycle we see more risk in that,” he said.
While investors are being picky, not every loan is bound to run into trouble.
B&G Foods Inc. Tuesday boosted a loan it’s seeking to purchase the Green Giant and Le Sueur vegetable brands from General Mills Inc. to $750 million from $500 million, according to data compiled by Bloomberg. The company also reduced the interest margin it will pay on the debt to 3 percentage points more than benchmarks from as much as 3.5 percentage points.
“If you’ve got a high-quality credit, it’ll actually go well," said Okada. "There’s plenty of cash for those transactions.”
But given the recent price declines in buyout loans, investors have been pushing for higher interest rates to offset losses on price, according to Jonathan Insull, a New York-based money manager at Crescent Capital Group LP, which oversees $18 billion of below-investment grade debt.
The average spread on first-lien loans has risen to 4.6 percentage points more than lending benchmarks, the highest monthly average since January, Bloomberg data show. That’s up from about 3.8 percentage points in May.
“People are looking for a bit more cushion in the form of spread,” said Insull. “You are going to see more pushback.”