August 2018: Notes from the Desk
Mergers & Acquisitions (M&A)
With $1.17 trillion of M&A announced by US firms year-to-date, 2018 remains on track to surpass 2015's record-setting volumes. Despite headlines related to global trade disputes, we have seen several large and significant transactions announced over the past few weeks across various industries. In the Real Estate Investment Trust (REIT) space, Brookfield Asset Management announced that it will acquire Forest City Realty Trust for $25.35 in cash per share. The trend towards REIT deals has been triggered by selling in the sector that has pushed many REITs to trade at discounts to their net assets values. We expect this trend will continue. In healthcare, RegionalCare Hospital Partners, owned by Apollo Global Management, entered into a definitive agreement to acquire LifePoint Health for $65 per share. In chemicals, Platform Specialty Products (PAH) agreed to sell its Arysta LifeScience division to UPL Ltd for approximately $4.2 billion in cash. Proceeds from the deal are expected to be used to pay down debt at PAH. Banking consolidation also appears to be accelerating as rising short-term rates and softer regulatory hurdles for community and regional banks benefits the sector. Most recently, FCB Financial Holdings agreed to be acquired by Synovus in a stock-for-stock deal. The transaction was valued at approximately $2.7 billion.
Overall, transactions that require regulatory approval from the Committee on Foreign Investment in the US (CFIUS) or China’s State Administration for Market Regulation (SAMR), such as Rockwell Collins/United Technologies, 21st Century Fox/Disney, and XL Group/AXA, are leading to wider deal spreads. The lack of clarity on the process and the difficulty in assessing political risks have weighed on these deals.
Despite regulatory headwinds that recently impacted some large deals (Time Warner/AT&T, Tribune/Sinclair Broadcasting), The New York Post reported “US regulators believe three national 5G wireless providers are needed to ensure robust competition. … After studying the Sprint-T-Mobile proposal for more than three months, the Department of Justice [DOJ], while not yet making a decision on the merger, now believes three carriers are needed to establish a true competitive marketplace, according to a source with direct knowledge of the thinking within the DOJ.” While this deal isn’t likely to be assessed until 2019, it will attract attention given the level of investor ownership in both the stocks and bonds of the companies involved.
Lastly, the Wall Street Journal recently published an article entitled How Investors Can Cash In on the M&A Boom (subscription required). The piece highlights the use of merger arbitrage funds as a way to capitalize on the rise in merger and acquisitions, and notes that a rising interest rate environment could lead to more favorable deal spreads.
Last week, Jamie Dimon, Chairman and CEO of JPM Chase, made headlines when he noted that investors should be prepared for a 5% 10-year yield. While Dimon’s comment did not contain any suggestion of a timeframe to reach such a yield, it certainly highlighted a known tail risk in the market.
Even prior to Dimon’s weekend comments, fixed income investors were concerned about rising interest rates, particularly amid solid US economic growth and the prospect of inflation. The primary solution for cautious fixed income investors has been to increase allocations to floating rate products, such as levered loans, or to invest in short-duration credit as higher short-term rates appear more compelling relative to longer-term yields. Consequently, flows to levered loan and short-duration funds has risen during 2018, and levered loans have outperformed high yield bonds year-to-date.
Investor demand for floating rate bank loans provided cheaper financing for many companies, but lending standards have weakened in the process. Since June, the trend toward loan issuance has taken a pause as investors push back on terms. This has pushed issuers to tap the high yield bond market again for capital, but the excess supply could create a negative impact on credit spreads. This could ultimately lead to opportunities to purchase new issues bonds with more attractive terms.
We think both the levered loan and high yield bond markets will remain active in the near-term as private equity (PE) funds have plentiful cash reserves, evidenced by KKR’s purchased of BMC Software and Envision Healthcare, Apollo’s purchase of Lifepoint Healthcare, and various smaller PE acquisitions including Mitel, Essendant, and Web.com.