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One day, the children of today’s company finance directors will ask their mothers or fathers: what did you do when money was so cheap?
An important reason why corporate bond markets have rallied this year – pushing prices into what many investors fear is bubble territory – is that corporate treasurers have remained cautious. They have used ever lower borrowing costs largely to refinance existing debt more efficiently; company default rates are still exceptionally low.
That may be changing. As part of a shift away from traditional bank finance, bond markets are funding a flurry of merger and acquisition activity in Europe and the US. Last month, for instance, Numericable, the French cable operator, and Altice, its parent, broke European records by issuing $16.7bn in bonds to pay for its acquisition of SFR, a telecoms company.
Central bankers, who have slashed benchmark interest rates to historic lows, could argue this is precisely what they wanted: a revival of entrepreneurial “animal spirits” that boosts economic growth. But the M&A surge is occurring at a strange moment in the credit cycle – and could also spell dangers.
Urge and surge
Usually M&A activity rises when borrowing costs are high, near the peak of an economic upswing. This time, it is surging when growth is weak and investors are eking out incremental increases in yields by piling into corporate debt. There is no handy guide to what happens when, in the words of Matt King, credit strategist at Citigroup, “the urge to merge meets the dash for trash”.
M&A activity should be bad for credit markets. When companies lever up balance sheets, yields – which move inversely with prices – typically rise to reflect the increased risks.
But even as M&A fever rises on the back of Pfizer’s bid for AstraZeneca, its UK rival, we seem a long way from that point. What little increase there has been in the “spread”, or difference, in Pfizer’s bond yields over market benchmarks has been offset by the broader market rally.
Target companies, meanwhile, have benefited. Yields on bonds issued by Alstom, being pursued by General Electric, have fallen sharply on expectations of its finances being strengthened within a larger group.
One reason for the calm is that companies have big cash holdings, and debt markets capacity to absorb issuance is large – thanks to investors’ “hunt for yield”. Numericable and Altice received orders of more than $100bn for their bonds and loans package. Last year, Verizon, the US telecoms operator comfortably sold $49bn of bonds to finance the acquisition of Vodafone’s stake in Verizon Wireless.
Another reason is that corporate activity remains firmly within the bounds of what even conservative bond investors would consider rational. As the post-2007 crises eased, companies used favourable credit markets to lock into low interest rates and fund share buybacks, pushing equity prices higher.
Having cut costs, companies are ready for a “second phase of balance sheet optimisation,” through synergistic acquisitions, says Robert McAdie, head of fixed income strategy at BNP Paribas. “We haven’t seen a deterioration in credit quality as a result. At the moment there are enough buffers to support valuations – so we don’t see a re-pricing.”
Few if any US corporate issuers have bonds maturing in the near term that they are worried about, adds Mike Kessler, European credit strategist at Barclays. “If you are a corporate treasurer, you can tell your chief executive that deals can be financed at levels which in a few years time, with hindsight, may look fantastically attractive.”
Even when interest rates rise, the corporate sector’s financial strength will not deteriorate rapidly. A rise in bond yields is not the same as a share price fall: the latter reflects badly on executives; the former demonstrates astuteness in borrowing when borrowing costs were low.
But the longer term impact on economic growth and company finances will depend on whether bond markets are used to expand output and job creation. The evidence so far is not convincing.
M&A activity reflects increased business confidence and could improve resource allocation. It is not the same as increasing capital expenditure.
“Even Apple, at the forefront of global technology, when given nearly-free money by the bond market, seems not to be able to find anything better to invest in than share buybacks,” says Mr King at Citigroup.
If economic growth is not sustained and risks rise, what might look like fantastically attractive borrowing costs for companies may not convert into fantastically attractive yields for investors. What did they do when money was so cheap? They kept their fingers crossed.