Bankers keep eye on cap rates in high-yield M&A trades

Fri Jul 19, 2013 10:49am EDT
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By Joy Ferguson

July 19 (IFR) - As US Treasuries have stabilized and yields tighten anew, bankers are optimistic that pending M&A trades in the US high-yield bond market will find strong demand from investors - and not hurt the underwriters bringing the deals to market.

Some major LBO and merger & acquisition deals are in the works, including for US pork giant Smithfield Foods and industrial machinery maker Gardner Denver, and market participants are hopeful that the recent bout of volatility that sent rates surging is under control, and won't have any further negative impact on the transactions.

Bond underwriters set so-called cap rates on new issues - effectively, the level beyond a bond's pricing at which they agree to purchase the remainder of the new bonds that investors do not buy - and generally give themselves an additional 150bp to 200bp of cushion when doing so.

But this has proved to be tricky of late because mergers and acquisitions take much more time to arrange than the simple selling of debt - meaning that recent and upcoming deals were planned before the recent surge in rates.

For example, Valeant Pharmaceuticals, the last large M&A issuer to tap the high-yield market, nearly approached its cap rate. The USD1.625bn eight-year non-call three senior unsecured notes tranche, part of the financing for Valeant's purchase of Bausch and Lomb, priced in late June at 7.5%. This was heard to have been around just 25bp under its cap in the high 7% range.

If banks don't syndicate out a new issue and have to price it at a rate over the cap, they swallow the extra costs. And if they syndicate out the bridge loan to the buyside, then it's the investors who suffer if the follow up bond prices over the cap rate.

To avoid getting stuck, bankers have lately been moving up the cap rates by as much as 200bp. An LBO deal that was expected to price at 7% with a 9% cap rate, for example, may now come with a 8.5% or even 9% coupon expectation and a 10.50% or 11% cap.

"Investment banks are going back to the ultimate issuers with higher caps, so it's up to the issuer to decide how much they are willing to bear in market risk," said one investor.   Continued...