Leveraged finance bankers are heading into 2014 with the same old nagging doubts about whether M&A will finally pick up, but this time round there is an even greater desire for a resurgence as refinancing opportunities fade.
US high-yield volume is running at USD331 billion so far this year, close to last year's record high of USD336 billion, according to Thomson Reuters data, with more than half of that driven by companies issuing new bonds at historically low yields to pay down more expensive debt.
But with interest rates on the rise, the incentive for companies to refinance is becoming less obvious, while the urgency to do so has also diminished as a vast swathe of debt maturities have been pushed out to 2017, according to Moody's.
To maintain the same kind of momentum in the market and to keep fees flying in, M&A and leveraged buyout activity has to make a comeback.
"M&A is always the most interesting thing to talk about. It shows how companies and investors are looking at the world, and it's how banks make money," said one senior leveraged finance banker.
But acquisition financing has accounted for just 22%-24% of high-yield supply over the last three years, according to Goldman Sachs data. "The question is how much of the decline in refinancings is offset by increases in M&A driven financings, both corporate-to-corporate deals and leveraged buyouts," said Marc Warm, head of US high-yield capital markets at Credit Suisse.
DRY POWDER
A number of factors may hinder a revival, including the rally in equities. Buoyant financial markets may be good for investment bank fees overall, but if sponsors sway towards IPOs rather than sales, then high-yield bond supply may slow until that capital gets recycled in new deals.
Rising rates may also make leveraged loans a more attractive substitute for high-yield bonds, which have the additional caveats of punitive call costs for financial sponsors.
One factor buoying hopes of an LBO revival, though, is the amount of cash stashed in private equity hands.
Sixty-seven US-focused buyout funds have raised USD67.3bn this year, according to private equity data group Preqin, marking a 40% increase on last year and the highest total since 2008.
"There is a tremendous amount of dry powder at the sponsors which should lead to increased buyout activity, but the strength of the IPO market and valuation discipline amongst the sponsors has resulted in less LBO volume than we would otherwise expect," said Warm.
Lawyers are certainly busy, particularly on possible mid-sized leveraged buyouts.
"Volume has picked up, with several auctions under way where we have been contacted in relation to the financing," said Robert Treuhold, a capital markets partner at Shearman & Sterling.
The retail sector could shape up to be reasonably active, with private equity firm Sycamore looking to broaden its reach following its purchase of Hot Topic and Torrid.
It is advanced talks to acquire the off-price chain store K&G of Men's Wearhouse Inc as well as Jones Group Inc.
"The pace of discussions that we are having has picked up, and there are a numbers of financial sponsors that are thinking about doing something," said one senior leveraged finance banker.
THE BIG GUNS
What everyone really wants to see, however, are the jumbo LBOs that require USD10-billion plus debt packages, like the kind seen for Dell this year.
There are some big bond deals heading the market's way in January, specifically to fund Community Health's USD3.9 billion acquisition of Health Management Associates.
But other than a potential buyout of Time Warner Cable and possibly Vodafone, the cupboard for those types of deals looks fairly bare.
AT&T has been scouting for targets, with Vodafone seen as the most attractive once its deal to sell out of Verizon is completed in the new year.
And speculation has been building for weeks that Charter Communications will bid for TWC, while other suitors including Comcast and Cox have also been thrown into the mix.
Some bankers say that the debt financing would likely exceed the USD13.75 billion debt that backed Dell. There's certainly no problem raising that amount of debt as Dell, and others, have proved.
Aside from big corporate deals, however, there remains the same problem of raising equity for large buyouts as financial sponsors shy away from club deals.
"With large deals, it's the equity that is the problem, it's never the debt," said the banker.
Another leveraged finance banker said that activity was likely to be driven by strategic acquisitions between corporates, than jumbo LBOs. One thing is certain: terms could get aggressive as banks circle fewer deals.
Currently it's normal to see six or seven banks competing for each LBO. And with less product floating around, investors may be tempted to buy riskier, more leveraged debt.
Leverage has generally been in the five to six times multiple range this year.
"Leverage has not gone to crazy levels, and for now there definitely seems to be a cap on how far people will push things," said the first banker.
Booming IPO market could cap bond supply
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