A Vicious Circle.
It’s not like stocks need any additional problems. But they’re getting them.
On Monday, junk bonds suffered their worst sell-off since October 6, 2011, according to S&P Capital IQ LCD’s index of “high-yield flow names.” The index is comprised of large junk-rated companies, including Charter Communications, Chrysler, Dish Network, Dollar Tree, First Data, Reynolds Group, Rite Aid, Sprint, and Valeant Pharmaceuticals.
The average bid plunged 246 basis points from 94.44 cents on the dollar to 91.98. The worst plunge and the worst level since that infamous October 6, 2011, when a flare-up of the euro debt crisis wreaked havoc in the global markets. The average yield jumped to 8.62%. Almost all of the components of the index were in the red. LCD:
This time around, declines are linked to ongoing concerns about global economic growth and the commodities crunch, with the latter, in particular, forever defining the state of play for late 2015. The decrease builds on a 186 bps retreat on Thursday, for a net-432 bps decline week over week, and it follows negative observations more mildly in the prior three readings, for a decline of 578 bps dating back four weeks.
It was the day when the index crashed through the oil-panic-low of December 16, 2014. But this time, the sell-off is broader. Today, there was a tepid uptick, not the violent bounce seen the day after October 6, 2011.
Here’s how the junk-bond debacle bleeds into stocks. Part of the fuel that powered stocks to such vertiginous heights over the last few years was the M&A boom. Companies bid for each other with huge premiums over the already inflated stock prices. These deals were mostly funded with shares, of which companies could print an unlimited amount, and with debt, of which even over-indebted junk-rated companies could issue nearly unlimited amounts, thanks to the Fed’s policies that drove yield investors to near-insanity.
So far this year, companies announced $3.2 trillion of M&A, according to Dealogic, rivaling the all-time record of 2007 that ended in the Financial Crisis. M&A booms need cheap debt and high share prices. But both of them are becoming elusive.
On first blush, corporations are still able to sell bonds as if there were no tomorrow: Year-to-date, issuance in the US soared 11% from a year ago to $1.03 trillion, the highest year-to-date volume ever, Dealogic reported last week. Average deal size rose to nearly $1 billion, the highest ever. There have been 12 mega-issues of $10 billion or more year-to-date, totaling $154 billion, more than four times the volume last year. Investment-grade bond issuance soared by 22% to $802 billion, the highest year-to-date ever. The superlatives keep coming.
But… US marketed junk bond issuance, according to Dealogic, has plunged 16% YTD from the same period last year, to $223.8 billion.
“We’re surprised that sectors that had performed better, such as chemicals, are now being adversely impacted,” Brad Rogoff, head of credit strategies at Barclays, told the Wall Street Journal about the junk bond debacle.
Junk bonds have funded a lot of acquisitions over the past few years, including those by Charter Communications and Valeant Pharmaceuticals. But junk bonds are getting harder to sell. As yields have soared, interest payments are going to be more burdensome for issuers, which makes these bonds even riskier and more unpalatable for investors. And that’s going to undermine M&A.
As I reported a couple of days ago, junk-rated Olin Corp. needed to fund its acquisition of the chlorine products business of Dow Chemical. It originally offered $1.5 billion in two tranches: eight-year notes and 10-year notes, guided around 6.5% and 6.75% last week. But investors had lost their appetite. There was talk of yields in the mid-to-high 7% range to pull the deal off. On Friday, Olin ended up selling only $1.22 billion of bonds, and it had to offer a yield of 9.75% and 10%.
That’s getting expensive to fund an acquisition. And it’s going to hard to service the debt.
Junk-rated Altice, the Netherlands-based French multinational telecom company, tried to sell $6.3 billion in bonds to fund its acquisition of Cablevision Systems. But on Friday, according to S&P Capital IQ LCD, it was able to sell only $4.8 billion, with two tranches yielding 10.125% and 10.875% – over a percentage point higher than bankers had initially guided.
Both Olin and Altice will have to make up the shortfalls by borrowing from banks, but banks are getting cold feet on these deals and are demanding all kinds of concessions, including good collateral.
A company like Olin, whose shares have plunged 53% in the past six months, cannot use its shares for an acquisition. Sellers get leery, and the market would punish Olin for that sort of stockholder dilution. And given the troubles Olin had with its bonds, it’s shut out of the M&A market. More and more junk-rated companies whose shares and bonds have plunged fall into this category. This may even trip up M&A-meister Valeant Pharmaceutical, whose shares have crashed 43% in less than two months, and whose bonds are now getting slammed too.
Companies with an investment-grade rating and high and stable stock prices have no trouble in the M&A market – they rarely ever do. But at the troubled end of corporate America, the junk-bond debacle and plunging shares are closing the M&A window, and this is very bearish for stocks, which ruins the M&A party even more – a perfect vicious circle.
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