Midway through November this year, the total dollar volume of M&A in the Europe, Middle East and Africa region had blown past the full year totals going back to 2013, according to Dealogic.
EMEA-based companies had completed $1.33tr of deals half way through the final quarter of 2018, versus $943bn for the full year 2017.
“There has been solid M&A activity this year,” says Charlotte Conlan, EMEA head of high yield bond and loan syndicate at BNP Paribas. “Perhaps not the blockbuster deals like 2017, but across Europe we have seen a consistent corporate activity providing opportunities.”
Most of 2018’s successes were frontloaded to the start of the year with $394bn and $416bn of M&A completed in EMEA in the first and second quarters, respectively. This tailed off sharply to $212bn in the third quarter and just $89bn for the first half of the usually busy final quarter.
“The M&A market started off pretty robust this year,” says David Pepper, head of EMEA loan capital markets at Bank of America Merrill Lynch. “While [wider lending] volumes have held up reasonably well, M&A [lending] volumes have been depressed, largely driven by high valuations given historically buoyant equity markets and uncertainty in the global political climate.”
Brexit, a trade war between the US and China and political backlash against Saudi Arabia for the murder of journalist Jamal Khashoggi at its consulate in Turkey all slowed down deals at the tail end of this year, including the postponement of an up to $50bn loan for Saudi Aramco’s acquisition of a majority stake in compatriot petrochemicals firm Sabic.
Standout non-leveraged EMEA deals that involved financing arrangements in the first half of 2018 include media company Informa’s $5bn acquisition of events firm UBM, completed in June; industrial conglomerate Melrose’s £8bn hostile purchase of engineering group GKN in April, and energy firm E.On’s €20bn purchase of Germany’s Innogy. Those three saw around €12bn-equivalent raised through the loan market. However, they also highlight the problem that M&A brings to the loans market — fewer banks are being invited into M&A financings.
BAML was sole lead on Informa, Lloyds and RBC underwrote Melrose, and BNP Paribas was sole underwriter on E.On. Great news for them, but it meant that the financing, and subsequent league table positions and fees, were highly concentrated.
“We’ve seen more sole mandates over the last two years in investment grade acquisition financing than in recent history,” says Jon Abando, managing director, EMEA loan capital markets at JP Morgan in London.
Usually, this would just indicate that there is a healthy competitive market, but with many lenders in western Europe missing budgets by around 20% in 2018, there is a widespread belief that loans desks are expected to get on to more of these deals. The private nature of the M&A market makes this inherently difficult.
“You need multiple revenue streams to have the optimum balance across markets,” says Conlan at BNP Paribas. “We remain confident about the flow of M&A deals, but the market remains unpredictable.”
The concentrated lender profile on M&A deals has prompted touchy comments from the parts of the loan market that have missed out, with some European and Asian loan desks more vocal than their US peers about how increased M&A volumes have not helped their P&L. None of these banks wanted to go on the record.
“There’s only been a handful of winners in M&A this year, mostly US banks,” says one senior loans banker, echoing the sentiment of many of their peers. “For a lot of us, it hasn’t helped too much.”
This is despite investment grade loans in EMEA hitting $673bn-equivalent in 2018 by mid-November, already up on the $673bn-equivalent signed for the full year 2017, according to Dealogic data.
There is some evidence that the grumbling is sour grapes. Comcast’s long-running £30.6bn debt financed buy-out of the UK’s Sky, for example, saw Commerzbank and Santander muscle their way on to the deal in the later stages to join BAML and Wells Fargo’s lending group. Though the deal was denominated in sterling, it was arranged by US desks.
There have been other factors at play too that have kept the bulk of the market out of the loop.
“Other themes that have been on the rise were smaller bolt [on] acquisitions,” says Pepper at BAML, “which essentially have been too small to syndicate and therefore go completely under the radar as these acquisitions are structured as club deals.”
Pepper adds: “Secondly, borrowers [are] choosing just one or two banks to provide initial bridge facilities.”
Sticking to a few banks for a bridge loan has notable benefits for chief executives. Fewer lenders means fewer moving parts to keep track of — a blessing in a complex acquisition. Also, borrowers can pick banks they know will deliver and can keep details out of the public domain.
“To maintain confidentiality, corporates are increasingly using just two or three banks for large scale M&A financings,” says Pepper.
Other banks have seen similar rationales for just a few lenders being picked for event-driven deals.
“We’ve heard from clients that there are a number of factors at play,” says Abando at JP Morgan. “The main one is the particular dynamics around the M&A, but confidentiality and speed are considerations too. The more guys you have around a deal pre-announcement, the riskier it is for both of those things, confidentiality especially.”
Betting on bonds
Some lenders have said throughout the year that they are happy to take sole risk of chunky, multi-billion dollar bridge loans for M&A because the bond market remains so strong. In some cases, bridge loans have remained undrawn because companies have been able to go to the bond market to refinance at longer tenors and better pricing that quickly.
This might not last indefinitely — the winding down of the European Central Bank’s Corporate Sector Purchase Programme and rising interest rates at Western central banks have already put upward pressure on bond yields — although bankers remain fairly relaxed about the ramifications this will have on top rated borrowers.
“If there is greater volatility in the bond markets, then I don’t think it will fundamentally change lender behaviour,” says Abando. “If people are more risk-averse, then there will be a natural broadening of underwriting banks on any given deal. That being said, in investment grade acquisition finance, I don’t think banks are going to lose a significant amount of risk appetite.”
In other parts of the market, interest rate hikes have been a boon for leveraged borrowers on the hunt for acquisitions, as liquidity has poured into the asset class as investors look to hedge against the rate rises.
“Liquidity is still very strong, both bank and institutional,” says Conlan at BNP Paribas. “The interest rate environment makes the floating rate product more interesting for some investors and we are aware that some are re-allocating towards loans.”
Of course, what is good for borrowers is not necessarily helpful for loans desks. “High levels of loan liquidity continue to keep the market very competitive,” says Conlan.
For some acquisitive companies, loans do not make sense to fund purchases, and they have instead turned to other pockets of capital.
“Some corporates have used their CP programmes or share swaps to fund acquisitions in lieu of the loan market,” says Pepper at BAML.
More banks might be able to get in on the action if borrowers can be convinced to rely more heavily on term loans to part finance acquisitions, though this will be a tough sell.
“All the data we have suggests that most corporates look to fund 60%-70% of their M&A financing through a bridge-to-capital markets takeout rather than term loans,” says Pepper at BAML. “Term loans, however, remain relevant to acquisition facilities as they allow corporates to deleverage through free cashflow.”
Term loans are easier to repay early than bonds. Term loans also help acquisition borrowers avoid a potentially volatile bond market, which could be particularly enticing for chief executives as the pricing structure in bridge-to-bond loans means borrowers are rewarded with refinancing quickly via bonds, putting them at the mercy of the capital markets.
“Banks remain short loan assets and demand for paper has ensured that issuer clients have two very strong financing options in bonds and term loans,” says Conlan at BNP Paribas.
However, a heavier reliance on term loans means that the lucrative ancillary business for M&A lenders of bond mandates disappears, and the economic reason for banks to lend cheaply.
“If you have a choppier bond market then in some cases a bigger term loan makes sense,” says Abando at JP Morgan. “But it will fundamentally change the proposal that banks are served up with. If a company is no longer going to take the bridge-to-bond route, then it changes the return dynamics, so there will be more of a discussion around terms.”
Abando adds: “I don’t think there will be a material shift in pricing, but it will provoke discussion.”
There might be plenty of time for discussion and little else in the coming year, as the geopolitical tensions that hit the latter half of 2018 look set to spill over into 2019.
“You have potential disruptions on the horizon so naturally everyone is feeling less confident,” says Abando. “That might dampen M&A activity. It’s hard to make firm judgements, but some of the factors, like destabilised political conditions, will clearly have an impact.” GC