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The optimist's scenario

by Max Frumes | Published September 7, 2011 at 2:01 PM

If the credit marke

ts slowed to a shuffle in August, it could be because they're getting ready to gear up for the fall when they will attempt a leap across two market chasms called uncertainty and volatility. Dreams of megabuyouts will remain earthbound, and debt will undoubtedly cost more, but professionals nonetheless appear to be gearing up for some action after a difficult summer.

That, at least, is the optimistic way of viewing the current situation.

It's not without evidence. In a bullish maneuver as shocking for its timing as it was for its news value, Avista Capital Partners-backed ConvaTec Inc. apparently launched a potential bidding war for wound-care company Kinetic Concepts Inc. on Aug. 21, the last day of Kinetic's go-shop. Goldman Sachs Group Inc. and Jefferies Group Inc. lent their imprimatur to the spoiler bid, saying they were "highly confident" there would be financing available to beat the existing offer, from a group led by Apax Partners LLP, that already included $5 billion in debt, of which $2.15 billion was a high-yield bond bridge.

In addition to Kinetic, recent buyouts with financings to watch will be CKx Inc., which has a $360 million bridge waiting to be taken out by bonds; medical IT company Emdeon Inc., which will be syndicating out $1.2 billion of term debt and $750 million of unsecured notes, according to a Securities and Exchange Commission filing; and SunGard Higher Education's $1.77 billion purchase of Datatel Inc., which indicated that the deal will include bridged high-yield bonds. Don't be surprised to see these get financed, albeit at higher prices than anticipated.
"There's lot's of capital and people who still will commit, and deals can get done," says a source familiar with processes for several private equity deals coming to market.

High yield would have to pick up if private equity firms hope to make sizable investments and complete some deals that already have firm commitments. There were only four high-yield issuances in August, totaling about $1 billion, only one of which was for a buyout. That's down from a total of $23.38 billion in August of last year, according to Thomson Reuters Loan Pricing Corp., and is the lowest tally since December 2008.

The flight from risk was tangible, for as of Aug. 24, $4.63 billion had flowed out of high-yield mutual funds, a record for the month, according to Lipper FMI. The bid and ask spreads on bonds widened to traffic-jam trading in high-yield names, while the spread between benchmark U.S. Treasuries and some high-yield bond indexes jumped nearly 200 basis points, indicating a dwindling confidence in the asset class.

The loan markets too provided plenty of ammunition for Cassandras, with just seven bank loans syndicated in August, the lowest total since August 2009 and below the year-to-date average of 59 deals per month, according to Standard & Poor's Leveraged Commentary & Data. Yet dealmakers remained markedly confident; there are $12.9 billion of M&A loans on the forward calendar to come to market, down from a recent high of $24.3 billion in June, according to LCD. And the general M&A deal volume this August still surpassed that of last August.

And those with hopes for a post-Labor Day reset can ponder the fact that outflows from high-yield funds slowed radically in the week ending Aug. 24 to just $127 million. Whatever the lack of confidence that junk will perform, it runs up against a minimal default rate for corporate high-yield bonds of 1.5% forecast by the end of the year, according to Moody's Investors Service Inc. That's down dramatically from 5.5% a year ago, and even 2.3% in July. The reason: Junk-financed companies are already cutting costs, locking in cheap debt and sitting on giant stockpiles of cash to ride out a possible recession. Buyout professionals and debt investors continue to make the point that August is always slow and the macro-issues essentially made vacation a better alternative than trying to put money to work. Once everyone is back from the beach, and if exogenous factors can be kept to a minimum, credit, they say, should return.

"Things look pretty good for a rebound here," says high-yield investor Larry Post of Post Advisory Group LLC. "We'll have to see what the real market is when there's no hurricanes in New York and other distractions," he says.

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