Bondholders should not fear European M&A wave

Mike Della Vedova (pictured), portfolio manager on the T. Rowe Price European High Yield Bond Fund comments on the implication of an increase in mergers and acquisitions on corporate bonds.

The steep rise in M&A activity among European corporates over the past 18 months is attracting a lot of attention – and dividing opinion. For some, it is a worrying trend, rekindling memories of the leverage-oriented environment that preceded the 2008 financial crisis. For others, however, it speaks of corporate optimism and growing confidence in Europe’s economic prospects, both of which bode well for a healthy market outlook.

Certainly, any trend toward re-leveraging bears monitoring, while a larger volume of M&A activity also increases the potential for event risk, as the companies involved experience fundamental change.

However, European companies today are generally more financially secure than was the case in the lead-up to the financial crisis. The severe economic and market turbulence experienced during the crisis period not only forced companies with the weakest finances out of business, but also shocked the rest into action.

Echoes of 2008 crisis are erroneous

In the years since the crisis, management teams have focused on streamlining operations, paying down debt, cutting costs and accumulating cash. The overall effect of this prudence is that corporate balance sheets today are notably healthier than in 2008, characterised by greater cash reserves and, importantly, significantly improved cash-to-debt ratios.

Further evidence of today’s more robust corporate environment can be found in the lower level of defaults among European high yield issuers. In 2014, the default rate was 2.6% by volume, well below the long-term average default rate of circa 4.8%.

Access to funding is a fraction of the cost of pre-crisis period. With the cost of debt today considerably lower than in the lead-up to the financial crisis in 2008, companies are taking full advantage of the low rates for a range of purposes, including funding more interesting corporate deals. For investors in high yield, this makes for an exciting and opportunistic environment.

German company HeidelbergCement, a bond issuer in 2014 and an active player on the M&A front, offers a good illustration of just how much more attractive the cost of borrowing has become for European companies over recent years. Back in 2010, BB+ rated HeidelbergCement issued a bond paying a coupon of 6.75%. Fast-forward to 2014 and the still BB+ rated HeidelbergCement launched its latest bond with a coupon of 2.25%.

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