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Credit Insights

Rising LBO Potential Induces Debt Sell-Off

As M&A activity heats up, many investors have been scouring their portfolios to reduce exposure to companies that could be subject to debt-leveraging transactions.

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The average spread in Morningstar's Corporate Bond Index widened 2 basis points last Monday in sympathy with the sell-off in the equity markets and traded in a narrow range for the rest of the week. The initial bout of fear was driven by the price declines in Italian and Spanish sovereign bonds on news of looming losses in the Italian banking system as a result of derivative trades gone awry and a widening political scandal in Spain. The credit market tried to improve Friday, but the attempted rally seemed to fizzle out early. With the blizzard bearing down on New York, many traders either took the day off or left early.

The long-rumored leveraged buyout of  Dell (DELL) (A+/UR-) was finally officially announced last week, with four banks committing nearly $14 billion in loans to complete the transaction. In addition,
 Liberty Global (LBTYA) (B) announced plans to acquire
 Virgin Media (VMED) (BB-/UR-). As part of the transaction, Liberty will increase Virgin's leverage to 4-5 times earnings before interest, taxes, depreciation, and amortization from 3.5 times currently, adding more than $3 billion in debt to the Virgin capital structure to fund the cash portion of the deal. As merger and acquisition activity is heating up, many investors have been scouring their portfolios to reduce exposure to companies that could be subject to debt-leveraging transactions. As such, the industrials sector widened slightly more than the financial-services sector as prices fell for the bonds of potential LBO targets. Given the regulatory nature of the financials sector, we do not believe there is a reasonable chance that private equity sponsors can structure a leveraged buyout that would effectively subordinate existing bondholders.

David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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