Yves here. Things could get very interesting for all those private equity investors….
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street
Standard & Poors warns of the worst drop in the “net outlook bias” since the Financial Crisis.
The world’s biggest beer conglomerate Anheuser-Busch InBev’s acquisition of the world’s second biggest beer conglomerate SABMiller, both of which are getting their clocks cleaned in the US by over 4,000 mostly upstart craft brewers, isn’t going to improve the flavor of their brewskis. But the $106-billion deal is going to flood the market with one of the largest bond offerings in history.
It’s the first big bond deal this year. To fund and complete last year’s M&A frenzy, many more bond deals are looming on the horizon, at the worst possible time since 2009, according to Standard & Poor’s.
AB InBev has now started marketing this bond monster. In October, it was rumored that it could eventually issue $55 billion of bonds, plus up to $15 billion of loans. The US portion of the deal now being marketed is likely to be about $25 billion, Bloomberg reported. That alone would make it the second largest offering to finance an acquisition, behind Verizon’s $49 billion offering to fund its Vodafone deal.
About $630 billion in mega acquisitions from the record M&A frenzy in 2015 are scheduled to close this year and are still waiting for funding, according to Bank of America strategists cited by Bloomberg. They include Dell, Anthem, and Newell Rubbermaid. On top of the acquisitions this year.
But the end of the credit cycle has set in. The ratings agency downgrade tango has started. Defaults are rising. Credit is tightening up. Investors are getting a little more skittish…. S&P Capital IQ Global Credit put it this way in its new report titled, “Global Corporate Rating Trends 2016: Largest Negative Swing Since 2009”:
Corporate issuer ratings globally are at their highest negative level since 2009.
Standard & Poor’s Ratings Services has the most number of ratings on negative outlooks relative to positive ones at Dec. 31, 2015, since June 2010.
The net outlook bias deteriorated to a negative 11% at Dec. 31, 2015, four percentage points down from six months previously. This constitutes the worst half-year change in the net outlook bias since the 2008-2009 global financial crisis.
OK, I get it, this is going to be a wild mess.
For the US market, Standard and Poor’s credit outlook is “cautious.” It is fretting about the “rising negative outlook bias” for 2016:
The commodity sectors and leveraged finance remain most vulnerable.
Investment-grade issuers face risks from M&A and the resulting pressures on credit metrics.
Investors’ cooling appetite for risky securities and rising interest rates could also spur tighter lending conditions.
We believe credit risks are rising as the corporate credit cycle worsens. Corporate issuers can achieve only so much margin improvement solely through cost-cutting, in our view, so they will need stronger revenue growth to survive this credit cycle.
Turns out, that hoped-for “stronger revenue growth” is exactly what has been lacking. According to FactSet data, 2015 is going to be the year when S&P 500 companies seamlessly chained together four quarters of revenue declines.
Since revenue growth is so elusive, companies have gone on an acquisition binge to show some kind of growth. Meanwhile, Standard & Poor’s expects the US corporate trailing-12-month speculative-grade default rate to jump to 3.3% by September 2016, from 2.5% in September 2015, and more than double the default rate in September 2014.
New debt to finance M&A activity is particularly on the hot seat, and borrowing costs could rise further across the sectors as investors sell existing holdings to load up on the new higher-yielding bonds. Just the announcement of a merger can widen bond spreads – the difference over Treasury yields – as investors are getting nervous about the financing needed to fund the deal.
And ratings agencies have begun to downgrade many of the M&A queens, based on the massive new debt they’re taking on to complete the deal and the deterioration in credit metrics that the deal will engender.
Already, bond spreads – the difference over Treasury yields – are getting jumpy, particularly at the lower end of the spectrum. For investment-grade debt, spreads have widened to 1.8 percentage points, from about 1 percentage point in mid-2014, according to BAML’s US Corporate Master Option-Adjusted Spread index. Average high-yield spreads have widened from 3 percentage points to 5.7 percentage points over the same period. And at the bottom of the scale, spreads of CCC-or-lower-rated junk bonds have spiked from 6.4 percentage points to 17.2 percentage points, the highest since June 2009.
And the disaffection is spreading to tech deals. Bloomberg:
Bonds in the tech and oil and gas sectors, which account for the biggest chunk of acquisitions expected to close this year, could see the most widening, analysts and investors said. Wells Fargo is recommending that clients reduce their exposure to companies in sectors that are likely to see more acquisitions, such as technology, where companies have room to add debt and revenue growth is slowing.
So with immaculate timing, AB InBev’s bond offering and the flood of other issuance come at the end of the credit cycle, after the Fed has finally decided to stop flip-flopping and raise interest rates while credit quality is deteriorating and revenue growth has stalled or reversed as the global economy is slowing. Investors are opening their eyes for the first time in years to glance at some of the risks they were blind to before. And risk aversion is cropping up again as a factor in the math.
The record acquisition-financing hangover from last year is going to pressure bond markets further. Investors might be less open to willy-nilly absorb mega acquisition bond deals. This will make it more expensive to raise acquisition-related debt. Some of the deals will flop and fail to get funded – marking the end of the M&A frenzy. And since that frenzy drove part of the stock market run-up, it’s disappearance is going to be sorely missed.
Credit markets have already left their skid marks on the hedge fund industry, and now investors are reacting. This data “will be met with dismay by the hedge fund industry.” Read… Hedge-Fund Dazzle Has Peaked, Record Closures Next