Covid-hit industries seek ways back from the brink
The coronavirus has smashed the usual hierarchy of companies, large and small, creating new winners — and many losers. While 2020 was about finding ways to keep their financial lifeblood flowing, in 2021, more permanent solutions will need to be found. This will include bond funding for those still shut out — and M&A. Mike Turner reports.
The economic damage wrought by the Covid-19 pandemic is profound, and will leave scars that last for many years — overwhelmingly concentrated in a few industries. But as 2021 begins, the capital markets are balanced between two more immediate considerations.
On one hand, the impact on creditworthiness has only begun to be felt, and is likely to get worse before it gets better. On the other, the hope that effective vaccines might be on the way is causing a surge in optimism and enthusiasm that is irrepressible, after such a grim year.
The challenge for those responsible for financing the corporate sector will be to navigate the waves of optimism and gloom that are likely, at various times during 2021, to buffet individual sectors in very different ways.
One of the most immediate effects of the pandemic was to upend the usual pricing standards for corporate debt. Credit spreads that roughly correlated with credit ratings went out of the window, to be replaced with spreads aligned to sectors.
The pandemic has been catastrophic for any business that relies on people being able to congregate in person. The biggest casualties are airlines, some of which have been burning hundreds of millions of cash a quarter, even with their entire fleets grounded.
Even the strongest airlines were locked out of the European bond market for six months from March. The might of the European Central Bank’s bond buying programmes was not enough to bring spreads down to something palatable for issuers.
Many, such as Deutsche Lufthansa and Air France KLM, required billions of euros of government bailouts to keep them solvent. Others, such as the UK’s EasyJet, turned to emergency government commercial paper programmes and the syndicated loan market.
Commercial and office property is in a better position, but only just. Working from home has kept people out of city centres, turning offices and shopping malls into ghost towns. Fixed income investors became acutely wary of the sector, though not completely dismissive, as with airlines.
In early April, Unibail-Rodamco-Westfield, the world’s largest shopping mall owner, with A3/A- ratings, issued an €800m 10 year bond at a spread of 280bp — a full 95bp more than lower rated distiller Pernod Ricard (Baa1/BBB+) had printed a 10 year a day earlier.
As the last quarter of 2020 began, the future for the worst affected industries was looking increasingly dire. A second wave of Covid-19 infections was sweeping through Europe and a fresh spate of national lockdowns had begun. Companies had drawn down their revolving credit facilities months ago and were eating up cash faster than they could find financing to cover the losses.
Then came the vaccine breakthroughs. Almost overnight, the prospect of people being able to meet in close proximity, and spend money on the industries that facilitate that, seemed within grasp again.
“Our mid-term view is that Covid vaccines are coming,” says Giulio Baratta, head of investment grade finance, debt capital markets, for EMEA at BNP Paribas in London. “Implementation will take weeks, but we are not concerned too much because central banks will continue to ease and support markets.”
The European Central Bank’s bond buying has ground spreads tighter since the depths of the crisis. The iTraxx Europe Main index of credit default swaps dipped below 50bp on November 24 for the first time since the pandemic began. The Crossover hit 264bp on the same day.
This tightening trend for spreads will not stop as long as the ECB keeps buying. But when vaccines eventually arrive, the spreads that have drifted wider in industries such as airlines, hotels and real estate are likely to tighten much faster than those in sectors which have already substantially recovered.
“Clearly, there will be a convergence trend,” says Baratta. “From an investor perspective, it should help them spot opportunities for relative value.”
For airlines, the bond market started to creak back open towards the end of the year. Ryanair, rated BBB/BBB and seen as the pinnacle of investment grade airline issuers, printed an €850m 2.875% five year bond in September. It made notable concessions to lure investors, such as the conservative maturity and building the book in eye-catching yield terms, rather than the investment grade market’s usual spread marketing.
The gambit worked. The deal let loose a torrent of giddy enthusiasm among syndicate desks, because not only was this the first airline to come to market since the crisis had started, but it had managed to print 12.5bp inside fair value.
But no other airline managed to capitalise on the momentum. Finnair squeezed out a sub-benchmark hybrid capital issue to existing investors at a wince-making 10.25% coupon.
It was not until the end of November, after the vaccine news, that Lufthansa had a crack at the high yield market. The Ba2/BB- rated company sold a €1bn 3% six year bond on November 24 that drew more than €4bn of demand.
Regaining access to term funding in 2021 will be a welcome breath of fresh air to companies that have been gasping through 2020. But much more important will be lockdowns, travel restrictions and quarantine rules being decisively eased.
“In Asia, when they reduced lockdowns, hotels were very busy and local flights were fully booked,” says Guillermo Baygual, head of industries coverage and co-head of EMEA M&A at JP Morgan. “It would hopefully bounce back very quickly here too as lockdowns are eased.”
This should bring much needed relief to affected companies’ credit metrics. Leverage ratios have rocketed as the earnings part of the Ebitda calculation evaporated. Cineworld, the trans-Atlantic cinema operator that was battered by the shutdown of non-essential businesses, had to get a waiver from lenders on its June 2020 leverage covenant test, and reset the December 2020 test to nine times Ebitda, an amount higher than Cineworld’s enterprise value at the time.
Not everyone is so hopeful that the bounceback will be rapid. The major credit rating agencies reckon it will be at least three years before airlines, for example, start to resemble the industry they were before Covid.
“Commercial real estate, transport, aviation — there will clearly be a recovery; first reactions are positive in terms of growth,” says Baratta. “What it will take to go back to the previous reality may be a matter of a few years.”
Yet even if it does take until almost the middle of this decade for companies to recover, the bond and loan markets have shown themselves capable of financing most sectors.
“Credit markets will be there, because they have demonstrated an abundance of liquidity and a solid backdrop,” says Baratta, “which is sustained by the policy interventions, which are clearly there to stay.”
The loan market, in particular, proved its mettle when the pandemic first hit. Banks signed tens of billions of short-term, bridge and crisis funding. The bond market was closed for nine days from the start of the crisis, and, as soon as it re-opened, issuers in stronger industries started printing debt to term out the short loans they had taken on.
The recovery, like the economic effects of the crisis, will be bumpy. This means there will be chances aplenty for M&A, as the companies that are coming through the crisis in better shape look for bargains among struggling rivals.
“There will be lots of opportunity for M&A next year,” says Baygual. “We are already seeing it in the US, with the major oil and gas companies buying small and medium-sized upstream companies. This is the way it will happen in Europe too.”
Some of this derives from how the markets have discriminated between firms in allocating their capital. “Bigger companies have been able to keep strong balance sheets and get plenty of liquidity, but the small and medium-sized companies have not had so much market access,” says Baygual. “This means that for some people it will make more sense to sell [their business].”
Not every sector will be capable of hosting M&A, even when there are wide disparities in how individual companies are doing.
“For airlines, M&A could be difficult because of regulation, and for airports there are no material synergies,” says Baygual. “But for other sectors there will be lots of opportunity. There is plenty of liquidity in the market to fund event-driven opportunities.”
Working from home is a new and seemingly long-term reality for millions of white collar workers. With it come issues that did not exist when staff were working in offices.
“A spike in phishing attacks, malware spam and ransomware attacks has forced companies digitising their processes to double down on IT and cybersecurity improvements,” says Henrik Jeberg, a director at M&A adviser Hampleton Partners in San Francisco. “The IT security services segment has seen a rise in M&A activity, as firms continue to outsource their IT and cybersecurity needs.”
Since the pandemic began, US professional services company KBR has bought cybersecurity company Centauri for around $800m, while IT automation company Ivanti has snapped up mobile security company MobileIron for $872m.
“We see sectors expanding,” says Baratta. “Utilities, where business plans are being reviewed and clearly predicate for confidence in business growth, telecoms and tech have been very steady. There may be other sectors where combinations will be forced by defensive plays.” GC