Over the past few weeks some notable mergers and acquisitions (M&A) took place involving hundreds of billions. FedEx acquired TNT for USD4.8 billion, Heinz announced that it will merge with Kraft Foods and, just this week, Shell decided to take over BG in a USD70 bn deal. Thomson Reuters estimates that during Q1 some USD700 billion were exchanged in M&A deals making this the strongest Q1 since 2007; for the US, Q1 2015 saw the largest volume since 2000!
What is more, the flurry of deals comes after a strong 2014 during which Thomson Reuters calculates that USD3.5 trillion was spent in M&A deals worldwide, the largest amount since 2007. To put this figure in perspective, during 2013 the amount dealt was below USD2.5 billion. The largest transactions took place in the US but total M&A activity saw double digits increases in both Europe and US.
In my opinion the trend is likely to continue, with KPMG and Mergers & Acquisitions magazine concluding in a survey of over 735 US M&A professionals that “an impressive 82 percent of respondents said they were planning at least one acquisition in 2015”. The major factor? According to the same survey “large cash reserves”.
Indeed, the US corporates have been building cash balances post-crisis but with the economic outlook improving their shareholders are calling for them to put the cash to work. The response was to increase share buybacks (effectively returning the cash to shareholders), dividends and spend some of their reserves to acquire other companies. Lower cash is, all else equal, negative for bonds as it leads to worse credit metrics. Having said this, in some case the synergies created through merger can offset the negative implications of lower cash.
Such trends are observable in special for large corporates, which in many instances carry investment grade (IG) ratings. As such, I am of the opinion that at least until the ECB-fed optimism fades in EUR IG space, bond investors might disregard the higher yields offered by the US IG bonds as fears of re-leveraging could prevail.
How about Europe? I am of the opinion that the pickup in M&A activity does not bear the same negative credit implications it does for US corporates. This is because (i) cash burn through dividends and share buybacks has been comparatively low in Europe and (ii) investors might find comfort in the fact that higher M&A activity speaks of greater confidence in the economic prospects; after several years of delayed investments and prevailing deflationary fears, seeing businesses more confident is due to boost markets optimism.
As regards high yield companies, they are often M&A targets rather than acquirers, resulting in a situation wherby the credit implications depend on the financial profile of the bidder as well as on the structure of the transaction (i.e. if the deal is financed through debt, equity or mix). If the company is acquired by a stronger corporate, the bondholders should see strong returns as the credit rating of the two merging companies will converge. A recent example is Heinz’ (rated BB-) merger with Kraft Foods (rated BBB) which brought a 9% gain for the holders of Heinz 2025 bonds. Thus, for high yield investors, in order to manage the event risk associated with M&A I think it is important to have a good knowledge of the names held in portfolios, their funding strategy and sectorial trends. Alternatively, one can opt to invest in high yield funds which bring greater diversification and professional expertise.
Another food for thought is that the telecommunication sector has been at the centre of M&A activity, leading in terms of value last year. Several other transactions could take place over the next few months, some of which have been long anticipated and considered to be game changers for some credit names. This likely underpinned the relative resilience of the sector during the late-2014 risk-off period. A case in point is the polish broadcaster TVN for which markets were anticipating on a possible takeover by an international company; ultimately it was acquired by the IG rated Scripps Network. Another example is the Italian company Wind Telecom for which bond prices have been fluctuating in line with the speculations around a merger with Hutchison Whampoa Ltd.
Raluca Filip is Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.