Trading desks have been rushing to keep up with the latest spate of leveraged buyout and mergers and acquisitions reports that are the only source of juice in a market where credit-default swap spreads and volatility have been grinding lower. Dealers across the Street are flogging research teams to come up with trading ideas for clients to make the most of LBO-related spread movements.
Firms including Deutsche Bank, Lehman Brothers, Goldman Sachs and Bear Stearns have started to craft so-called LBO viability scores, to estimate where the five-year CDS might trade on an LBO headline, as well as to estimate where the CDS could trade if management opposed an LBO over a short time period. Bear Stearns, for example, calculates CDS for hotels company Starwood could widen out 145 bps to 300bps if it attracts serious buyout interest, or it could tighten 55 bps to 100bps if it dispels the rumors of an LBO.
In the last few weeks dealers have been suggesting credit players buy protection on a tailored basket of perceived event-risk credits and fund this by selling three times as much protection on the high-yield index. The basket names--typically there are about 20--must trade between 17 and 20 basis points wider than initial price over six months for the trade to break even, according to dealers. That means at least seven to eight percent of the basket must widen by 200250 basis points and at least one announcement to go private must occur.
Selling CDS and buying equity calls as a hedge if credit players think an LBO rumor is overdone has also emerged as a popular trade within a heightened chatter environment. For example, last week Bear Stearns was pitching this strategy for Louisiana Pacific, which has seen a lot of takeover speculation but a low run in its stock price.
This trade is also popular when multiplied across a sector, especially the media sector. Tribune Company is currently trading as a perceived LBO candidate, and last week a brewing bid for The Boston Globe was also stirring up protection prices on its owner The New York Times Company. The prospect of a straight sale for media companies, however, is not as likely as asset sales and spinoffs, explained debt analysts. For example, Tribune may sell some assets which could trigger CDS tightening.
