Buyout Bets Wane as Economy Keeps LBOs in Check: Credit Markets

, a record $1.6 trillion of deals were announced from 2005 to 2007, according to data compiled by Bloomberg. Acquirers have to put up more equity, and the amount of debt that targets take on relative to earnings is less than during the buyout boom four years ago.

“Credit spreads are pricing very high chances of LBOs, yet the feared LBO boom has yet to ignite,” said Alberto Gallo, a credit strategist at Goldman Sachs Group Inc. in New York, who last month recommended investors sell protection on companies with credit swaps that jumped on the speculation. “We are in an environment where growth is accelerating, but remains at a low level. Leverage is scarce and expensive.”

Seagate Talks Collapse

Seagate Technology Plc, the world’s largest maker of disk drives, said last month it ended talks with private-equity firms for a leveraged buyout and instead authorized the repurchase of as much as $2 billion of its stock. Talks collapsed with buyout firm TPG Capital after the suitor wasn’t able to find other partners to raise enough equity financing, a person familiar with the matter said last month.

Private equity firms are typically borrowing 4.7 times the company’s earnings before interest, taxes, depreciation and amortization costs, compared with 5.5 times earnings in 2006, according to Goldman Sachs analysts.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar-maturity government debt fell 1 basis point to 175 basis points, or 1.75 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. Spreads reached a 12-week high of 177 basis points on Nov. 30. Yields averaged 3.76 percent yesterday.

Corporate bonds worldwide have returned 0.59 percent this month, bringing this year’s gain to 5.6 percent, according to the Barclays Capital Global Aggregate Corporate Index.

IBM Sale

International Business Machines Corp. sold $1 billion of bonds, four months after issuing $1.5 billion of debt maturing in 2013 at the lowest interest rate on record at the time, Bloomberg data show.

IBM’s 2 percent notes due January 2016 pay 55 basis points more than similar-maturity Treasuries, Bloomberg data show. Its 1 percent, 3-year notes, issued Aug. 2 at a spread of 30 basis points, traded at 99.778 cents on Dec. 3 to yield 1.085 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Moody’s Investors Service upgraded the senior unsecured rating of the Armonk, New York-based company’s debt one level on Nov. 23 to Aa3 from A1, citing a growing emphasis on higher- margin software and services.

Bonds from New York-based Citigroup Inc. were the most actively traded U.S. corporate securities by dealers, with 120 trades of $1 million or more, Trace data show.

Toshiba Bonds

Toshiba Corp., the world’s second-largest maker of flash- memory chips, raised the size of a planned bond sale to 110 billion yen ($1.3 billion) from 80 billion yen, according to a person with knowledge of the matter. Proceeds will repay “loans and maturing commercial paper,” Toshiba spokesman Ken Shinjo said in a telephone interview today, declining to elaborate.

It will be the biggest debt sale by a Japanese manufacturer since Toshiba raised 120 billion yen in January, including 70 billion yen of 1.18 percent, four-year bonds priced at a 50 basis-point spread, according to data compiled by Bloomberg.

Investors should be buying bonds in all categories of U.S. securitized debt, in part because the market will continue to shrink next year, Bank of America Merrill Lynch analysts led by Chris Flanagan wrote in a year-end outlook published Dec. 3.

It will contract by an estimated $629 billion this year, compared with about $1 trillion of growth in each of 2006 and 2007, according to the report. Net supply across U.S. fixed- income markets will probably total $1.1 trillion in 2010, down from a record $2.4 trillion in 2007.

‘Exceedingly Bullish’

U.S. securitized debt may shrink by $270 billion next year, led by a drop in non-agency home-loan bonds that lack government guarantees, they wrote. Issuance will be limited as potential borrowers and investors remain wary and new regulations curb sales, while defaults eliminate outstanding debt.

“We recognize that heading into 2011, recommending an overweight of all sectors of securitized products may appear exceedingly bullish,” according to the analysts. “However, the return performance for 2010 indicates that would have been the appropriate strategy for this past year.”

A benchmark credit-default swaps index in the U.S. fell after Federal Reserve Chairman Ben S. Bernanke told CBS Corp.’s “60 Minutes” program the central bank may boost purchases of Treasuries beyond the $600 billion announced.

Bondholder Protection

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell 0.8 basis point to a mid- price of 90.8 basis points as of 5:20 p.m. in New York, according to index administrator Markit Group Ltd.

The index has declined from 99.4 basis points on Nov. 30 amid speculation that European Central Bank policy makers will ramp up measures to contain the region’s sovereign debt crisis.

Bernanke also indicated U.S. unemployment, which rose to 9.8 percent last month, the highest level since April, may take five years to fall to a normal level.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 0.4 basis point to 107.38. The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan fell 1 to 107.5 as of 8:24 a.m. in Singapore, Royal Bank of Scotland Group Plc prices show.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Leveraged Loans

The Standard & Poor’s/LSTA US Leveraged Loan 100 Index fell for a second day, declining 0.02 cent to 91.74 cents on the dollar. Prices on the index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, have declined from 92.72 cents on Nov. 9, the highest since May 3. Leveraged loans and junk bonds are rated below Baa3 at Moody’s or less than BBB- at S&P.

In emerging markets, relative yields widened 5 basis points to 245 basis points, after declining for three straight days, according to JPMorgan Chase & Co. index data.

Swaps on Cardinal Health more than doubled over six days from 59.8 basis points on Oct. 14 on speculation it could be acquired by private-equity firms. The swaps reversed after the company said Oct. 26 that it wasn’t in talks.

McKesson Corp.’s credit swaps have dropped to 49 basis points from as high as 96.6 on Oct. 25 as speculation cooled that the San Francisco-based drug distributor, which has a stock market value of $16.8 billion, could be acquired in a debt- fueled takeover. McKesson spokeswoman Ana Schrank declined to comment.

Dell Swaps

Contracts on Round Rock, Texas-based Dell jumped to as high as 129 basis points on Oct. 29 from 86 basis points on June 2, the day before its chief executive officer said he’s considered taking the company private. Swaps on Dell, which has a market capitalization of more than $26 billion, have dropped back to 102 basis points.

The swaps typically rise if a company is deemed a buyout risk because the debt added to its balance sheet to fund the takeover erodes its credit quality and leads to ratings downgrades.

Large jumps in swaps are typically unwarranted for companies with an enterprise value -- the sum of its stock and debt minus cash -- of more than $15 billion, said Nicholas Pappas, co-head of flow credit trading in the Americas at Deutsche Bank AG in New York. Companies that large, he said, are more likely to pursue mergers or acquisitions or buy back shares, he said.

The number of acquirers teaming up on a bid has shrunk, according to Pappas. “We are not seeing five sponsors in one deal as we did in the past,” he said.

‘Big Credit Event’

Buyouts “haven’t been a big credit event for portfolio managers as of yet,” said Rizwan Hussain, a credit strategist at Morgan Stanley in New York. “You should expect to see more in 2011, but it doesn’t seem to me you could have particularly aggressive leveraged events.”

Bank of America strategists are still recommending investors buy protection on potential buyout targets with market values of $10 billion to $20 billion whose swaps are cheap relative to the rest of the market.

Contracts on a company that’s acquired in a leveraged buyout can jump 300 basis points, Hans Mikkelsen, an analyst at the bank in New York said in an interview yesterday.

“The conditions are still there for LBOs, so it’s just a matter of time,” Mikkelsen said. “The market will tend to run with any kind of speculation that comes up because the downside is so big.”

--With assistance from Jody Shenn, Boris Korby and Katie HoffmannEditors: Alan Goldstein, Pierre Paulden

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Mary Childs in New York at mchilds5@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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