June 21, 2013 / 6:55 PM / 4 years ago

M&A borrowers set to test US high-yield markets

NEW YORK, June 21 (IFR) - Unrelenting volatility has kept junk-rated borrowers out of the funding markets in recent days. But with commitments for its M&A financing already in place, pharmaceutical giant Valeant has little option but to tackle a tumultuous market head on with a mega-sized deal.

In a sector that has seen just USD4.6bn of high-yield bonds sold over the past two weeks, Valeant Pharmaceuticals is attempting to sell USD3.225bn through a two-part offering. If placed next week, it will be the third largest high-yield bond issue this year.

“It’s not a conducive time to issue,” said Dan Heckman, a senior fixed income strategist for U.S. Bank Wealth Management, who expects a huge change in the environment for new deals.

“You are going to have to give up so much in premium,” he said.

Until the market settles at its new clearing level, investors are demanding north of 75 basis point premium to buy in the new issue market.

“If you went out now, I think the average issuer would be forced to give a 100 basis point premium,” said one leveraged finance banker. Three weeks ago, that level was closer to 25 basis points, the banker said.

M&A and LBO-related financings accounted for around 16% of high-yield issuance so far this year, according to Barclays, as companies refinancing at better levels dominated supply.

However, with opportunistic issuers now firmly on the sidelines, companies looking to borrow for event-driven deals are being forced to test even the most unfavorable markets.

“You really narrow down the issuance to people who need to be in the market,” Kevin Sherlock, head of loan and high-yield capital markets at Deutsche Bank, said at a press briefing this week.

“There will be a steady supply of deals, but at a lower level, because there is some LBO issuance that was backlogged that just has to get done.”

When an M&A or LBO transaction is scheduled to close, the funding has to be in place and settled by a given date, meaning underwriters have an obligation to market the deal a certain amount of time before closing.

The M&A backlog, which is currently around USD12bn, includes names such as Dell, BMC Software and Cooper Tire.

SETTING A BENCHMARK

The offering from Valeant, which will form part of the USD9.3bn financing package backing the company’s USD8.7bn acquisition of Bausch & Lomb, will be split between two tranches of senior unsecured notes due 2021 and 2023, and will be callable after three and five years respectively.

As a defensive healthcare name with an established curve, the deal is expected to act as bellwether.

“This will be the benchmark that will inform people in the weeks to come of what the new clearing level is, and how this trades will be indicative of the true health of the market,” said a syndicate official.

Bankers said the deal will have to come with a pretty considerable new issue discount, which could widen the rest of the curve even further.

As a regular issuer that already has a sizeable amount of debt outstanding, investors are reportedly already well bought in the name.

“I think there are people that will buy it, but if investors feel that they are at risk of losing assets through further redemptions then they will be forced to sell something else or their existing bonds in the name to make room for it,” said a syndicate banker.

The difficulty in raising cash at present will make the threshold to buy new paper pretty high, he said.

Valeant held an investor roadshow in New York on Thursday, and is meeting with investors in Boston on Friday before wrapping up presentations on the West Cost on Monday.

The deal, which has been rated B1 by Moody’s and B by Standard and Poor’s is expected to price next week via Goldman Sachs lead left bookrunner.

In a smaller-sized test of risk appetite, National Financial Partners Corp got a Triple C rated LBO deal priced just ahead of the Fed and resultant selloff on Wednesday.

The wealth management advisory firm downsized its deal to USD300m from an initial USD337m in favor of the concurrent term loan, which was upsized by the same amount to USD753m from USD716m.

NFP’s decision to go out alone in a potentially volatile session raised eyebrows. However, pricing before the Fed turned out to be a canny move as the synthetic indices lost more than a point in the afternoon session. In offering a 9% coupon, the deal was seen as less sensitive to a potential back-up in rates by investors.

MARKET CAPS

With more M&A deals still required to come to market, bankers say that they expect the range at which these deals will be underwritten - or caps - will rise.

A cap is the cushion that bankers are willing to underwrite in order to allow for market weakness or other circumstances that may lead a deal to price wider than originally expected.

Underwriters provide clients with a certain expected rate of where a bond deal may price, but give themselves what could be as much as 200bp of leeway.

If banks don’t syndicate out the deal but have to price the deal at a rate over the cap, they swallow the extra costs. And if they syndicate out the deal to the buyside, then it’s the investors who suffer if the deal prices over the cap rate.

Sources said the Valeant deal was half syndicated to investors, with the underwriters on the hook for selling the rest.

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