Europe's HY Market Settles into Normalcy
February 18, 2010
There was the year-long drought. Followed by the six months of feeding frenzy. And now? Recent signs on Europe’s high yield bond market point to increasing selectivity and prudence by investors, which has market participants daring to use words like, well, normal.
Case in point: a £550 million issue for Italy’s directories publisher Seat Pagine Gialle and a £425 million deal for British soccer team Manchester United. While most other high yield deals to hit the market since last summer have traded up after breaking on the secondary market, both these transactions actually traded down.
Seat was issued with an OID of 97.5 and traded down after breaking on the secondary to a low of 90.5. It subsequently climbed to 92, where it remains, sources say. Manchester United, which priced at 98, traded down to 90.25 after hitting the secondary. It is now trading at 91.5.
It has become clear that investors in the European high yield space are getting choosier about what they buy, and they are paying greater attention to deal structure, pricing and credit stories than they were a few months ago, said Christian Knitzschke, director of the high yield syndicate at RBS in London, which advised Seat on the bond deal
Investors also have a lot more choice, since so many deals are pricing, which is driving market dynamics as well. “There is more than one deal on the road at one time, so there are increased options for investors between currencies and maturities, between secured and unsecured transactions,” Knitzschke said. “People can steer their investments toward their choice, and this is reflected in the comments that we get from investors regarding what they want by way of terms and structure.”
This is a big change from a few months ago, when high yield bond investors seemed to jump at any deal banks brought to them, said Chris Brils, senior fund manager for the high yield team at Pall Mall Investment Management.
“Last year, in the aftermarket, just about every bond traded up, but now we’re seeing some bonds go up by three points and others trading down by five points,” he said. “There is demand, certainly, but investors are not buying everything because they can choose more.”
Brils believes that the high yield market in Europe has returned to a more “normal” state. While the long deal drought resulted in a frantic shopping spree when the market finally took off last summer, investors are now examining deals with greater scrutiny to see if they have a decent structure, if the issuer is in good financial shape, and whether the investment story makes sense, Brils said.
“Even though strong demand is still underpinning high yield, all the parameters you’d normally look for when analyzing a bond are starting to come back into play, which is a good thing for the market,” he said.
Both Seat and Man U were senior secured bonds issued for the purpose of refinancing a significant amount of existing bank debt. In the case of Seat, the proceeds from the new bond were not enough to completely refinance the company’s outstanding loans, which implies that it may approach the high yield market again soon, said Peter Aspbury, head of high yield research at European Credit Management in London.
Combined with the fact that the telephone directories sector is out of favor and that the capital structure already contained a large subordinated 2014 bond maturing ahead of the new issue, many investors felt they needed to be paid generously to participate. “But that does not necessarily mean that investors won’t find value in certain parts of the capital structure, and the bond did find its floor in the secondary market where it has held steady,” Aspbury said.
Unfortunately, the Man U deal had been bashed about in the British popular press, which didn’t help its case. Nevertheless, “it’s hard to concoct a plausible scenario in which the underlying asset value behind Manchester United would not be enough to cover the club’s debt, given the nature of today’s Premier League and the global brand appeal of its top teams,” Aspbury said. “However, investors still need to feel they are getting adequately paid for the headline risk surrounding such a credit and the potential for highly variable underlying cash flow.”
In contrast to these two deals, RBS recently priced $500 million in senior secured notes for Cable and Wireless Communications, which benefited from strong European investor support. The books were four times oversubscribed, Knitzschke said, and the notes, which started trading at 100.5/101 after launch, were seen quoted as high as 102/102.5 later in the day.
And while investors clearly have more deals to choose from, Pall Mall’s Brils believes that issuers, too, have more options than they did a few months ago. Many of the high yield bond deals that have priced in the past months were done because no other market was really open, and companies had to refinance their outstanding debt somehow, he said. But as overall market conditions have improved, issuing a high yield bond is now a conscious decision as opposed to one made out of necessity.
Moreover, junk bonds remain a cheaper source of subordinated funding than mezzanine, Aspbury said, so many leveraged buyouts will continue to go this route.
And there’s no dearth of bond deals in Europe: “There is a good pipeline and deals are still being road showed and are getting done, and that is a confirmation of the strength of the European market,” Knitzschke said.
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