The most stunning thing about the blockbuster M&A deal announced overnight, in which Italy's Danone offered to acquire organic foods producer WhiteWave Foods in a deal worth $12.5 billion, including some $2.1 billion of debt, is that the deal size represents a gargantuan 21.2x forward EBITDA multiple for WhiteWave, six turns higher than the average multiple of around 15 times in recent dairy deals. Just as stunning is that the entire deal will be 100% debt financed, once again confirming that when it comes to investment grade debt (which Danone is at least for now), there is no fundamental threshold that will stop yield-starved investors from allocating other people's money into highly-rated corporate debt.
The M&A deal was just the beginning. As Reuters reports, the scramble for IG debt is on full force today:
- AT LEAST TEN INVESTMENT GRADE COPRORATE BOND DEALS EXPECTED TO SELL THURSDAY - MKT SOURCES
- DISNEY, AMERICAN HONDA FINANCE, RAYMOND JAMES, SUNOCO, SUMITOMO AMONG ISSUERS EXPECTED - MKT SOURCES
Why this relentless appetite for corporate debt? The answer is two-fold. On one hand, with "risk-free" sovereign debt yielding near record lows, central banks are forcing anyone seeking yield to put money elsewhere, in this case presumable safe corporations, even though one can debate just how safe this universe is with non-financial corporate debt having doubled in the last 6 years from $3 to $6 trillion.
Another explanation, and one which goes to the mechanics of demand, comes from Bank of America which reveals something fascinating, namely that "while the $5.9tr US IG corporate bond market represents only 12% of that global market, it is now responsible for 33.0% of its total (effective) yield payment. In other words, nearly one in three (global) dollars paid out in the global IG broad market is paid to investors in the US IG corporate bond market."
That's right: in the new normal, the $6 trillion in US investment grade debt is now responsible for a third of all global yield pick up!
Here is the full take from BofA's Hans Mikkelsen:
Our belief in the willingness and ability of foreign central banks to ease and force foreign investors to reach for yield in the US corporate bond has never been greater. As such we expect to remain bullish US HG corporate credit until foreign growth picks up and the monetary policy stances of foreign central banks change. That could mean we are bullish for the remainder of the year and well into 2017, as it appears that foreign growth is declining - not increasing. Case in point Brexit is expected to push the UK into recession and shave a half percentage point off economic growth in the remainder of the EU, as well as a couple of tenths elsewhere. That is furthermore expected to lead the Bank of England (BoE) to cut rates and embark on doing QE this summer. Due to the resulting decline in interest rates the ECB could be forced to reach for yield further into peripheral debt as opposed to core. We also expect the Bank of Japan (BoJ) and other foreign central banks to ease. When foreign central banks ease foreign investors have only one place to go - the US corporate bond market.
This market is big
Consider the $49tr global investment grade broad market consisting of sovereign, quasi-government, corporate, securitized and collateralized debt. While the $5.9tr US IG corporate bond market represents only 12% of that global market, it is now responsible for 33.0% of its total (effective) yield payment. In other words, nearly one in three (global) dollars paid out in the global IG broad market is paid to investors in the US IG corporate bond market. That number is up from 28.5% last Thursday (pre-Brexit), 25.6% at the beginning of the year and 15.8% prior to the financial crisis (as of 6/30/2007, Figure 5). With furthermore significant foreign uncertainties – as highlighted by Brexit – we think that it would be difficult not to be bullish on US IG corporate bond spreads.
And, just to put away any doubt as to the underlying reason for this unprecedented leverage build up, even Bank of America now admits who the real culprit is:
Normally the US monetary policy cycle is synchronized with the economic and credit cycles. Specifically monetary policy easing coincides with the earlier stages of the economic and credit cycles - then monetary policy tightening comes later in the cycle at the time corporate balance sheets deteriorate (Figure 6). However this time is different for two reasons, as we emerged from a financial crisis instead of just a typical recession. First, the US economy faced a multi-year process of deleveraging, which significantly slowed the economic recovery. Second, there was an unprecedented monetary policy response in the form of QE, which sped up the aging of corporate balance sheets.
The impact of the financial crisis was to slow the economic recovery – we like to say that we are midcycle and the first half of the expansion took seven years while the second half will take three-and-a-half years. The impact of QE was to allow corporate balance sheets to move through the credit cycle much faster than the economy (Figure 7). As result there is now a disconnect between the economic cycle and the credit cycle, as corporate balance sheets are at a later stage.
For now, as the saying goes, the music - thanks to the world's central banks "unorthodox" policies - is playing, and all must and will dance. We wonder, though, how long before the $6 trillion in US corporate debt doubles again and whether in a few years we will be looking at mega M&A deals done at 40x, 50x or higher EBITDA multiples, and just how the market will justify to itself that this, somehow, makes any sense.