Failed mergers trouble for bond investors

BOND investors who have lent blue chip firms $181 billion (R2 trillion) this year to fund acquisitions just got a tough reminder that mergers can fail.

Money managers holding $35bn of Anheuser-Busch (AB) InBev bonds lost $137 million in one day when it looked like its purchase of SABMiller might fall apart. A busted deal would have allowed AB InBev to buy back the bonds it issued to fund the acquisition at 101c on the dollar, a bargain price for debt trading as high as 106.6c.

In the end, AB InBev and SABMiller patched up their differences, and for most fund managers the paper losses were just a blip. But more than $486bn of mergers and acquisitions have failed this year and if more deals fail, investors’ losses could be outsized.

Aetna’s $35bn bid to buy Humana, for example, which is being contested by the US Justice Department, could cost investors in some Aetna bonds more than $300m if the deal collapses. Walgreens Boots Alliance, which is trying to buy Rite Aid in a deal antitrust authorities are investigating in depth, could cost money managers more than $39m.

Potential losses are big because bond prices have risen so much this year. Yield-starved investors have clamoured to buy debt in recent months after the Federal Reserve slowed its plans to raise rates.

When a deal goes bust, the acquirer can often buy back debt it issued to fund the acquisition at 101c on the dollar, a process known as calling the debt. That level is far below where many bonds are trading.

Merger deals were at risk as US regulators clamped down on possible antitrust problems, and after the UK voted to leave the EU, wrote analysts at Goldman Sachs Group. Merger-linked debt accounts for about 20 percent of this year’s issuance, according to data compiled by Bloomberg.

Concerns

Antitrust concerns were particularly high now, said Ira Gorsky, an equity analyst at trading and research firm Elevation. US President Barack Obama issued an executive order in April to press government agencies to refer evidence of anticompetitive behaviour to the Justice Department and the Federal Trade Commission.

With more deals potentially falling apart, some investors were focused more on a bond’s absolute price in dollar terms, said Jason Shoup, a portfolio manager and fixed income strategist at Legal & General Investment Management America. “Break-up risk is one thing we’re… watching quite closely right now,” Shoup said.

The last company to call back debt after a failed deal was Halliburton, which redeemed $2.5bn of five-year and seven-year notes it issued in November to fund its failed takeover of Baker Hughes. That debt traded at 103.2c on the dollar before falling to below 101c.

Most investors in these deals bought the bonds when they were issued around par, so any losses from selling at 101 would mostly be on paper, after the bonds. But with yields having fallen so much, investors should consider the risks, Shoup said. – Bloomberg