Analysis: European dealmakers face shrinking debt options as recession risk looms

Golub Capital BDC

16/05/2022 07:00

* M&A financing seen as costlier and harder to access 
    * Investors flee junk bond market amid monetary tightening 
    * Riskier debt sales down 77% so far this year 
    * Morrisons underwriters take a hit - source
    * Private lenders step in with uptick in hybrid financing

    By Pamela Barbaglia and Yoruk Bahceli
    LONDON, May 16 (Reuters) - European dealmakers are
struggling to finance corporate takeovers as concern that the
region's economies may dip into recession is prompting debt
investors to demand bigger rewards for the risks they're taking
to get deals over the line.
    Global economic uncertainty and market volatility triggered
by the Russia-Ukraine war, coupled with monetary tightening from
the Federal Reserve and the Bank of England and expectations the
European Central Bank will follow suit, have made deal financing
costlier and harder to access, bankers and analysts say. 
    More than $390 billion worth of M&A deals have been
announced in Europe since January compared to $365 billion in
the same period last year - almost doubling 2019 volumes of $199
billion in the same pre-pandemic window, according to Refinitiv
data. 
    While banks have agreed to provide the necessary financing,
some are having to sweeten terms to find lenders willing to take
on chunks of their debt.
    "There are many variables in the market and investors will
be careful until these settle and the bid/ask gap tightens,
especially in Europe," said Anthony Diamandakis, global co-head
of Citi's asset managers franchise worldwide.
    "We are not seeing many new debt commitments at the moment
because the M&A deal volume feels light."
    Global corporate debt yields have soared nearly 200 basis
points on average this year. Those on euro-denominated
high-yield bonds have doubled to 5.5%, ICE BofA indexes show.
    Dealmakers say the financing struggle has not marked a death
sentence for new deals, and while M&A volumes are currently
subdued they could still recover later this year.
    But in the meantime some debt sales have run into trouble.
    In Britain, supermarket chain Morissons' 7-billion-pound
($8.6 billion) takeover by U.S. buyout fund CD&R is the most
notable deal to have hit a snag as the syndication of its debt
pile has been delayed by about six months.
    Lead banks who fully shouldered the Morrisons financing are
now left with more than 3 billion pounds of debt yet to be
syndicated, one source familiar with the discussions said.
    The banks - Goldman Sachs  GS.N , BNP Paribas  BNPP.PA ,
Bank of America  BAC.N  and Mizuho  8411.T  - had to place a
chunk of its debt worth about 1 billion pounds at a discount of
around 10% to be able to sell it to private lenders, the source
said.
    Goldman Sachs and CD&R declined to comment while Morrisons
and the other banks were not immediately available.
    M&A financing packages are usually underwritten months in
advance. Investment banks guarantee a certain interest rate to
prospective buyers but also include so-called "flex" provisions
in the deal terms allowing them to adjust the final pricing by a
certain amount if markets move significantly.
    If those are not enough to cover the increase in market
rates, the debt gets syndicated at deep discounts with banks
making up the difference, which may lead to a loss if it exceeds
their fees.
    
    UNDER SCRUTINY
    Leveraged buyouts came under increasing scrutiny after the
financial crisis as they are typically funded by loading a
significant amount of debt onto the target company against its
assets.
    Because of their high debt/equity ratio, they often involve
the issuance of non-investment grade high yield bonds, often
dubbed junk bonds as they carry a higher risk of default.
    But money is fleeing the asset class this year; European
high yield retail funds have suffered $20 billion of outflows,
or 6% of assets under management, according to BofA citing EPFR
data.
    "A lot of fixed rate high yield investors have cash today,
but are worried about outflows. As long as that worry is out
there it's going to be difficult to price sizable new deals,"
said Daniel Rudnicki Schlumberger, head of EMEA leveraged
finance at JPMorgan.
    Global high yield bond issuance is down 77% since the start
of the year, Refinitiv data shows, with European volumes down
nearly 75% compared to last year.
    After a 10-week shutdown of the European high yield market,
the longest since 2009, a pool of banks led by HSBC  HSBA.L  and
Barclays  BARC.L  launched an 815 million pound bond sale in
April to fund Apollo's takeover of British homebuilder Miller
Homes.  urn:newsml:reuters.com:*:nL2N2WV0C6
    A sterling tranche was priced at a deep discount of 93.45
cents to lure investors, with the banks also offering a higher
yield than indicated at the start of marketing, a lead manager
said.
    HSBC declined to comment while Barclays and Apollo were not
immediately available.
    Similarly, French private equity firm Ardian opted for a
junk bond to fund its 1.1-billion-euro ($1.2 billion) purchase
of Italian drug firm Biofarma Group on May 6.  urn:newsml:reuters.com:*:nL8N2TV0HJ
    BNP Paribas  BNPP.PA  and Nomura  8604.T  arranged a 345
million euro floating-rate bond to finance the Biofarma buyout
and ended up granting a large discount as well as tightening
investor protections in the bond documentation to get the deal
over the line, a document seen by Reuters shows.
    Nomura declined to comment while BNP Paribas and Ardian were
not immediately available for comment.
    Buyout fund CVC Capital Partners' foray into a major
European football league also struggled as the private equity
firm funded a 1.99-billion-euro investment in Spain's La Liga
through a 850-million-euro bond sale.  urn:newsml:reuters.com:*:nL1N2SV19Q
    Goldman Sachs, which led the bond sale, had to offer heavy
discounts on both tranches, according to a deal document seen by
Reuters. CVC and Goldman Sachs declined to comment.
    While most M&A financing is slated for the leveraged loan
market, which has fared better than junk bonds as floating rates
offer investors protection from rising rates, loan sales have
also slowed. Dealmakers say banks have become more selective in
funding transactions.
    "You want to have a clear understanding of any pass-through
issues like energy exposure or a potential drop in consumer
demand," said Simon Francis, head of debt financing in EMEA at
Citi.
    "It's about making sure you have a grasp on how performance
will be impacted by what's going on in the wider world."
    
    'MIX AND MATCH'
    Private lenders such as Ares, Blackstone  BX.N  and KKR
 KKR.N  are trying to fill the gap by charging higher interest
rates to provide cash to prospective buyers and rescue their
deals, bankers and investors say.
    The trend has been gaining traction since Russia invaded
Ukraine on Feb. 24.
    "Any staple financing that was agreed by banks before the
war in Ukraine will probably need to be re-evaluated," Francis
said.
    This year U.S. private equity firm Thoma Bravo has
repeatedly bypassed traditional banks and turned to a group of
private lenders including Owl Rock Capital, Blackstone, Apollo
Global and Golub Capital to finance the $10.7 billion purchase
of enterprise software firm Anaplan in March.
    The U.S. tech-focused investment firm went on using Golub,
Blackstone and Owl Rock in April to finance the $6.9 billion
takeover of New York-listed cyber security company SailPoint
Technologies.
    In Europe, private lenders have mainly operated as part of
so-called hybrid deals, where financing is sourced from both
private and public markets.
    Chris Munro, head of global leveraged finance at BofA, said
a number of upcoming financings could be backed by hybrid
structures.
    "Banks are still open for business and underwriting deals,
it's just terms have changed and structures are a bit more
conservative," he said.
    Yet, with banks turning leery, private credit funds are set
to extend their gains.
    "We're moving to a phase of mix and match. Private equity
funds are going to get quite creative around some of their
financing," Citi's Francis said.
    ($1 = 0.8085 pounds)
    ($1 = 0.9605 euros)
    

 (Reporting by Pamela Barbaglia and Yoruk Bahceli, additional
reporting by Andres Gonzalez; Editing by Emelia
Sithole-Matarise)
 ((pamela.barbaglia@thomsonreuters.com;  +442075427723; Reuters
Messaging: pamela.barbaglia.thomsonreuters.com@reuters.net))