Mergers Could Clog Flow of Junk Bonds
WSJ, Jan. 23, 2014
By Mike Cherney
Investors' healthy appetite for "junk" bonds may be tested in coming months if two supersize corporate takeovers take place.
Sprint Corp. has been pursuing a possible $31 billion purchase of T-Mobile US Inc., TMUS -3.24% and Charter Communications Inc. has launched an unsolicited $37 billion bid for Time Warner Cable Inc. Both would-be buyers have credit ratings below investment grade and each could sell enough bonds to break Sprint's record $6.5 billion junk-bond sale, set last year.
For years after the financial crisis, the thought of junk-bond-fueled megadeals would have been unthinkable, as Wall Street's merger machine struggled to shake off the rust of the financial crisis. But the $49 billion bond sale in September from Verizon Communications Inc., VZ -0.48% an investment-grade deal that was the largest corporate-bond offering on record, showed corporate executives and bankers alike that almost any sum is within reach.
Now, many investors say Sprint and Charter would likely have little problem selling the new bonds, underscoring the hunger for income-generating investments at a time of uneven economic growth, low interest rates and easy central-bank policy.
"It's a different world than it was just a few years ago," said Craig Elder, fixed-income analyst in the private-wealth-management arm of Robert W. Baird & Co.
Junk-rated bonds in the past have done better than investment-grade debt during periods of rising interest rates, in part because the higher yields on these bonds provide an additional cushion against falling prices.
Gary Herbert, a portfolio manager at Brandywine Global Investment Management, which oversees more than $38 billion in fixed-income assets, said he would consider buying new debt from Sprint or Charter if their mergers come to fruition. His firm has sold some bonds recently to make room for new junk-rated deals in the pipeline, he said.
"There's an appetite from the issuer, there's an appetite from the investor, and so when you have the two meet, it gets done," Mr. Herbert said.
Sprint and Charter would be selling new debt at an opportune time: Many investors say they have bought more bonds from junk-rated companies recently. Investment-grade firms sold about $1.1 trillion and junk-rated companies sold about $361 billion in the U.S. in 2013, according to data provider Dealogic.
Many analysts expect strong bond issuance in 2014 but less than in 2013, since interest rates have risen from last year's lows, increasing borrowing costs for companies. When rates rise, bond prices fall.
Junk bonds now yield 3.68 percentage points more than benchmark U.S. Treasurys. In 2007, before the financial crisis, that figure fell as low as 2.33 percentage points. In contrast, investment-grade corporate bonds are yielding 1.11 percentage points more than Treasurys, compared with recent lows of about 0.76 point in 2005, according to Barclays data.
The figures show that prices on junk debt have more room to rally than investment-grade bonds, some analysts say.
Mr. Herbert said the demand for junk debt was on display last week, when Community Health Systems Inc. sold $4 billion in bonds to help pay for its takeover of another hospital company. He said demand was so strong that he didn't get all the bonds he wanted.
"I think most investors felt the same way," Mr. Herbert said.
There are signs, though, that investors may be overindulging on the debt binge. The amount of debt carried by low-rated U.S. companies is approaching levels seen just before the last recession, according to Standard & Poor's Ratings Services.
Hundreds of billions of dollars of debt is scheduled to come due starting in 2016.
A sharp rise in interest rates or a drop in demand from investors could make refinancing challenging for some weaker borrowers.
"The question becomes, what does the capital market environment look like then?" said David Tesher, a managing director at S&P. "Many investors are concerned, but they can't predict what that environment will look like."
For now, investors are waiting to see whether Sprint and Charter ultimately succeed in their takeover bids. A merger between Sprint and T-Mobile would have to clear regulatory hurdles, and Charter has taken its takeover proposal directly to Time Warner Cable shareholders after being rebuffed by the company's management.
Putri Pascualy, senior credit strategist at Pacific Alternative Asset Management Co., which oversees $16 billion, said she would consider buying bonds from Sprint or Charter, depending on the interest offered on the debt.
She said companies offering large amounts of debt often reduce prices compared with already-outstanding debt in order to lure investors, who can then decide whether to hold the bonds for a period or "flip" them for a quick profit.
"If you could make a quick easy return at the beginning of trading, then in an environment where return is hard to come by, hey, we can't afford to be picky," Ms. Pascualy said.
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