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Are we nearing the end of the equity bull market? An ominous signal is coming from recent activity in the merger and acquisitions (M&A) market.
For market participants that were around from 2006-2007, the last few weeks brought up some memorable M&A names. For instance, First Data filed to go public this week. If you remember, KKR took First Data private in a $29 billion deal that was the last “big” one before the crisis. The shareholders did well, and the company was left with nearly $22 billion of additional debt, or 9x the amount on its balance sheet before the LBO.
The S-1 filed Monday shows that operating profit has grown from $1 billion in 2012 to $1.4 billion in 2014, but the company has still lost money with interest expense from the debt between $1.7-1.9 billion per year. Debt isn’t substantially lower, at over $20 billion, but arguably a lighter load with EBITDA trending higher. Despite a very untimely LBO in hindsight, First Data has reaped huge benefits of the low interest environment issuing monster leveraged loans and refinancing existing debt at lower costs.
It’s not just First Data. Additional pre-crisis deals such as Hilton and Sunguard are also expected to file and go public later this year. Both deals were scrutinized after the crisis but are now back in the money.
Maybe the most fun example was the July 21 Bloomberg article showing how Hostess Brands is issuing $1.2 billion in term loans only two years after acquiring the company in liquidation for $400 billion. A full $900 million of these new term loans will be used to pay the investors a dividend.
Crazy? Well, the investors took the risk to invest in liquidation, but this is awfully late-cycle-like.
So, are these all warning signs that the debt cycle has gone too far? People are really investing in a Hostess dividend recap after two years? Are even the worst deals from 2006-2007 looking good? There’s arguments on both sides. Economic healing and the benefits of the low rate environment have helped these companies heal and outgrow the debt somewhat, but investors should be cautious.
David Schawel, CFA, is based in Raleigh Durham NC and works as a fixed-income portfolio manager. His blog is Economic Musings, and you can follow him on twitter at @davidschawel.
