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Corporate Bonds

Corporate Debt: Flickers of hope across Europe as M&A stars align

The perennial dream of the investment grade loan market is a large company looking for finance to back its jumbo acquisition. With lenders flush with cash, borrowers confident and growth returning to Europe, this year might turn that wish into reality, writes Silas Brown.

‘‘The market is wide open,” says Antonio Alvarez Cano, managing director in M&A at UBS in London. “I don’t see anything that will stop M&A in Europe this year — growth is rising, interest rates are low and conditions in debt and equity markets are strong.”

For the investment grade loan market, mergers and acquisitions are the fount of business. Without takeover deals, lenders have little to do but refinance dull revolving credit facilities that are never going to be drawn. The loan market’s appetite for acquisition financing is deep, but for years has not been satisfied.

Since 2013, M&A that has either a target or an acquirer based in Europe, the Middle East or Africa has bumped along at about $1tr a year. Activity was brisker in 2016, at $1.3tr, but ticked down again in 2017. In 2006-8, the average was $1.9tr a year.

However, M&A bankers are confident the figure will rise this year. The market will be buoyed by healthy economic growth rates across Europe, and possibly a revival of Chinese activity, they believe.

“I think growth is the last piece of the puzzle,” says Alison Harding-Jones, Citigroup’s head of mergers and acquisitions in Europe. “There are a lot of companies with very highly valued acquisition currencies [i.e. equity] because valuations have got so high, and private equity firms have almost unprecedented amounts of firepower to spend.”

Improving growth has prompted politicians, like France’s President Emmanuel Macron, to call for corporate confidence across Europe.

Macron, in a speech at the Sorbonne in September, called on Europe to create champions of industry, to rival the titans of Asia and the US.

European companies are thinking along the same lines. The week of the Sorbonne speech saw Alstom, the French train maker company, accept an offer to merge its rail services with those of Siemens, in a bid to compete with China’s state-owned rival, CRRC.

“This Franco-German merger of equals sends a strong signal in many ways,” said Joe Kaeser, president and chief executive of Siemens, in a statement. “We put the European idea to work and, together with our friends at Alstom, we are creating a new European champion in the rail industry for the long term.”

Macron has a personal connection to mergers and acquisitions. The former Rothschild banker has been credited as the architect of Nestlé’s successful $12bn takeover of Pfizer’s infant nutrition business in 2012. His idea inspires hope in the minds of M&A bankers. 

“The vision of Mr Macron will push some to create European champions,” says Harding-Jones. 

Infrastructure and power are likely to be the busiest sectors, maintaining their momentum that grew in 2017. Hochtief, the German construction firm controlled by ACS of Spain, and the Italian company Atlantia are battling to buy the Spanish toll road operator Abertis.

BNP Paribas, Credit Suisse, UniCredit and Intesa Sanpaolo offered an €11bn bridge facility to support Atlantia’s €16.3bn approach last summer. 

In October, JP Morgan fully underwrote a €15bn bridge loan for Hochtief, which was then fully syndicated to 17 banks. Atlantia was expected to make a counter-bid, but by early December had yet to do so. 

Deals like this underscore the desire for corporate growth and activity, as well as the economic climate that supports it. “Historically, announcing big M&A moves would often cause share prices to tumble,” says Reinhard Haas, global head of loans at Commerzbank in Frankfurt. “But these days the share price tends to go up.”

It is not only pan-European activity, however, that is stirring. Chinese companies are limbering up to return to the shores of Europe.

Chinese make rational return

“We get the feeling 2018 will be a good year [for European M&A] — US tax reform, as well as Chinese buyers returning, will contribute to that,” says Alvarez.

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Chinese acquirers have been a big feature of international M&A markets in the past few years, with firms such as Fosun, HNA and ChemChina astonishing market participants by their appetite for deals. One banker calls the spree a “madness”, adding: “it became irrational — there was crazy money around.”

Since 2002, when there was just $2bn of overseas M&A by Chinese companies, according to Dealogic, the total has grown every single year, including 2017. But the 80% leap in 2016, to $140bn, has not been repeated. By December, completed deals in 2017 totalled $152bn, and their number was 27% down on 2016’s figure.

The slowdown is a direct result of China having clamped down on the more exuberant excesses. 

Once the legislation is enacted, firms will be forced to report acquisitions above $200m made through offshore holdings, and direct approval will be needed for acquisitions in more delicate areas, such as media and arms.  

An illustration of how important political influence is in Chinese dealmaking activity is that in the weeks leading up to the 19th National Congress of the Communist Party of China, held in the middle of October last year, deals stopped almost completely. They then began again straight after. Chief executives had wanted to be sure they were not going to fall foul of some new policy.

Experts have different explanations for why China has reined back the punchier acquirers, but they are convinced this is far from a blanket ban, and that outbound acquisitions will continue.

“I was in China recently and spoke to private and state-owned companies, and the motivation to invest in western Europe is clearly there — the interest is unbroken,” says Haas. 

President Xi Jinping is still very committed to the One Belt One Road initiative, and is promoting Chinese participation in core sectors, like power and infrastructure, across the world. Another huge initiative is Made in China 2025 — a drive to upgrade Chinese industry with innovative new technology, so that it moves to a higher part of the value chain and more of its inputs are locally produced.

“Chinese buying in western Europe will start to return and they will be meaningful investments in core industries,” says one M&A specialist. “2015 and 2016 were not normal — the Chinese will be much more focused on core European assets in 2018.”

The effect of this, and inter-European M&A, on the investment grade loan market is likely to be positive to some extent. Just how much is hard to predict, as acquirers always have choices about financing.

Only a small minority of deals get financed with syndicated loans — most are simply too small. 

Of the 86 loans totalling $153bn recorded by Dealogic in 2017, up to November, as having been for acquisitions, more than half were leveraged. That left 35 deals totalling $108bn in the investment grade market. The figure is less than half the total in 2015.

A supportive loan market is always useful for an acquirer. But it may still pay for an acquisition all in shares.

“Companies will try and walk the path between debt and equity, raising as much debt as they can before affecting their credit ratings,” says Harding-Jones.

Others go further, saying acquirers are increasingly willing to shoulder a rating downgrade for a year or two, for the sake of an important acquisition.

It can also be tricky for banks, deciding how to position themselves geographically. “The problem is calculating who pulls the trigger,” says Laurent Vignon, head of EMEA loans at Société Générale in London. “Germany was high in 2016, but low last year — whereas as the UK and France were strong in the first half of 2017.”

Keeping relationships alive

But however hard they are to forecast, ultimately the loan market depends on getting some large M&A deals to finance. Without that lifeblood, the large relationship groups of banks earning very little money for corporate revolvers could be hard to sustain.

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“In the absence of large ticket M&A, do issuers need such large banking groups?” asks David Pepper, head of EMEA loans at Bank of America Merrill Lynch in London. “This is a question based on a discussion we had with a number of clients during the latter part of the year.”

It is a question relevant to both lenders and borrowers. “Corporates are generally cognizant of the flow business, and the most sophisticated are highly aware of which ancillary business goes to which banks,” says Jose-Antonio Olano, global head of loan syndicate at Société Générale in London.

But ultimately, if a bank cannot scrape enough ancillary business out of a corporate relationship, in a climate of very tight pricing, there is cause to reach for the door handle. 

“It’s challenging,” says Charlotte Conlan, BNP Paribas’s head of EMEA loans in London. “You hear many banks saying it doesn’t make sense, and that it’s counter-intuitive.”

Even if a bank leaves a relationship, though, there is always a challenger rival in the offing, waiting to enter.

Refinancing recovery

Fortunately for banks, 2018 looks set to bring some dealflow, regardless of M&A activity. The second half of the year should bring a rise in refinancing business, as large companies that borrowed in 2014 take advantage of a tighter pricing market to extend their loan maturities. 

“The European investment grade loan market is still in the late stages of recovery. The incentive for early refinancing was lacking, but there will be refinancing pick-ups in late 2018,” says Haas.

The downside for banks is that companies still have the whip hand when it comes to margins. Pepper expects a rise in refinancing activity, and adds: “All the top corporates will look to apply pricing pressure on relationship banks.”

European refinancing fell by a quarter last year, according to Dealogic, as many companies had been tempted to go early in 2015-16.

However, if bankers have any luck — and economic conditions are surely more strongly in their favour than at any time since 2007 — they will be too busy in 2018 to worry about refinancing volumes. Some at least of the longed-for M&A deals will come through, and some of those will lead to chunky loans.   

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