Fasten your seatbelt for big and bold M&A
There is no deal too big to get done — that is the message for CEOs wondering about taking the plunge on M&A. Verizon’s jumbo takeover, financed in less than a fortnight, demonstrated just how obliging banks and investors will be when offered large amounts of cheap debt — a good sign for companies ready to make a move in 2014, writes Stefanie Linhardt.
Mergers and acquisitions bankers are looking forward to 2014 with gusto. Not because the long-heralded recovery in deal-making has begun — there was little hard evidence of that in 2013. But because pretty well all the conditions are now in place for corporate M&A to take off.
Above all, there can be no doubt about the availability of finance.
“It’s hard not to talk about Verizon, in any conversation about M&A,” says Kieran Ryan, head of event financing in global capital markets EMEA at Morgan Stanley in London.
It may only have involved a company buying out a joint venture partner in its own business, but Verizon Communications’ $130bn agreed takeover of Vodafone’s 45% share in Verizon Communications was for most observers the deal of the year in global M&A.
“It has shown there is no deal that can’t be done, within broad reason,” says Ryan. “When you look at the large number of banks that came into the [$12bn] Verizon term loan, that tells you that there is a lot of liquidity in the banking community to make the balance sheet available.”
The deal had been discussed for years, but news of it finally happening broke on August 29, when Vodafone confirmed press speculation about talks.
Then things moved fast. Bank of America Merrill Lynch, Barclays, JP Morgan and Morgan Stanley underwrote a $61bn bridge loan to part-finance the takeover, which also involved $60bn of Verizon shares. Nine days later, $49bn of the bridge had been refinanced with a single bond issue — three times bigger than the previous largest corporate bond.
The remaining $12bn of debt, in three and five year term loans of $6bn each, was signed and syndicated by October 1.
Change at last
M&A of this size and financings of this scope were only dreamt of in 2012. Globally, the largest merger or acquisition in 2012 was Glencore’s $38bn takeover of 66% of Xstrata, according to Dealogic. What has changed?
“After a very long period of inward-focussed management of companies, CEOs and boards have gained more confidence and are starting to look outward, are reshaping their portfolios and focussing on how to demonstrate growth to their shareholders,” says Denis Coleman, head of EMEA credit finance at Goldman Sachs in London. “M&A has become a more popular topic, as everyone has got their house in order and refinanced their debt.”
The macro environment has changed, too. Investors are engaged in a hunt for yield, while gaining more confidence about the eurozone and the finances of peripheral European countries and companies.
A notable sign of that recovery was the July 2013 takeover of Koninklijke KPN’s German mobile phone business E-Plus by O2 Telefónica Deutschland.
The latter company floated in Frankfurt in 2012, but was still 77% owned by Telefónica. The €8.1bn transaction was essentially already fully negotiated in 2012.
But then Spain was downgraded, leading Telefónica to fear that if it proceeded with the deal, its rating might be cut to speculative grade. So Telefónica’s board put the deal on hold.
In 2013, Spain’s sovereign risk had stabilised and Telefónica was able to revive the deal and complete it.
Telefónica, rated Baa2/BBB/BBB+, wanted to make sure the takeover would not cause its credit rating to fall to junk. Hence, the financing had to be leverage-neutral.
First, Telefónica Deutschland will buy E-Plus, paying KPN a 24.9% stake in itself and €3.7bn in cash, to be financed with a rights issue fully underwritten by Telefónica and its banks. Then, Telefónica will buy a 7.3% chunk of KPN’s stake for €1.3bn.
Of the €4.1bn of cash Telefónica will need, it said it would raise 50%-65% with hybrid capital securities — a goal it has already achieved, with €2.5bn of euro and sterling hybrids in September and November.
Chalk and cheese
Telefónica and Verizon portray two quite different styles of acquisition finance.
While Telefónica agreed the takeover in July, it is likely to wait until regulatory approvals to finance it. And its Baa2/BBB/BBB+ rating even before the takeover of E-Plus means that it will finance its acquisition mainly with equity or quasi-equity.
Verizon, on the other hand, raised half the purchase price in debt, and did so in a remarkably short timeframe. The extra debt caused rating agencies to downgrade Verizon from A3/A-/A to Baa1/BBB+/A-.
Both these kinds of deals will continue.
“People will look at the Verizon example of pre-emptively engaging in capital markets issuance and I think that might become a trend,” says Ryan at Morgan Stanley. “Banks will continue to provide companies with the standard maturities on the bridge but the company might now look to get in early and hit the market when they announce the transaction, while providing bondholders with call protection, should the deal for whatever reason not ultimately complete.”
In Verizon’s case, the bonds were issued with a standard 101 call, as regulatory approval is deemed highly likely to come through. Should the regulator block the takeover, Verizon can cancel the bond but will have to pay bondholders a 1% fee.
But Verizon’s takeover financing was interesting for another reason.
While Verizon includes 2013’s largest signed term loan ‘A’ portions, placed with banks, the deal still underlined the shift of M&A financing from the bank to the bond market.
“In the Verizon deal, $49bn was in a bridge-to-bond takeout and $12bn in a loan element — a percentage split of around 75-25,” says Ryan. “Pre-crisis, in most European M&A situations, it would typically have been 75% term loan and 25% bond. The trend of having most M&A financings in bridge format became even more entrenched and established in 2013, and most corporates are comfortable with this approach.”
Issuers, in any case, may have little choice but to accede to it, as these days they have to pay higher rates on drawn loans. Banks have learnt that a long term loan needs to be priced according to the costs they face, says Damien Lamoril, head of EMEA loan syndicate at Société Générale in London.
“Banks can afford to have a 12 month bridge which is priced a bit more tightly, because at the end it will be refinanced and they can probably participate in arranging the bond and get some additional fees,” says Lamoril. “But when it comes to drawn [loan] financing, lenders these days are extremely keen that there is a fair connection between their own funding costs and their lending costs.”
Bridges, meanwhile, are still an attractive business to be in. The return on capital on a bridge-to-bond is great, if it gets repaid within the term. Banks can book fees and margin and should be repaid within a year.
If not, the refinancing risk goes up, but with it the charged interest.
For borrowers, bridge loans are very cheap for the first six months, but have margin step-ups, which make them get more expensive after that.
The standard tenor for a bridge loan is 12 months in the US and usually one year plus one in Europe, Ryan says. But are issuers pushing for longer bridges?
“Some corporates look at a term loan as a de facto long-dated bridge,” he says. “They will [refinance] their bridge first in the bond market and will then issue again to take out their term loan.”
All set for deals to multiply
The new year should bring a continuation of 2013’s trends, but with — bankers hope — more examples. The so far still low interest rates could tempt companies to finally pull the trigger on M&A in 2014, says Coleman at Goldman Sachs.
“M&A transactions take months of preparation and negotiation and companies don’t always know if their proposed targets will be amenable to their strategic objectives,” he says. “With the increased discussion of tapering of QE, some corporates are saying ‘We have been looking at these targets for some time. Maybe we should seize this moment to make our strategic move, while financing is still very available and very cheap.’ Many companies have a couple of targets they are looking at and discussing with their boards.”
Trends in the stockmarket also presage more M&A in 2014, says Wilhelm Schulz, head of European M&A at Citigroup in London. “The equity and M&A markets are very much linked, so you can predict M&A activity by looking at the S&P [index], investor confidence, and how volatile the market is. I don’t see a huge amount of macro-economic risk on the horizon. Most of that has been worked through.”
In Europe, Schulz expects stronger growth in M&A than in the rest of the globe. M&A has been depressed in the region, around 50% below 2008 levels, while the other markets have regained or surpassed those levels.
Investors also expect deal activity to increase in 2014, according to Fitch. In its quarterly investor survey in October, the percentage of respondents expecting moderate or significant use of cash to fund M&A in Europe was at its highest level for over two years.
“Talking to my counterparties in the [loan] market, we would be prepared to support a large transaction in Europe,” says SocGen’s Lamoril. “Up to €50bn is doable, for the right borrower in the right sector, but we are still waiting for such a deal to come.” |