By Eleanor Duncan and Davide Scigliuzzo
NEW YORK (IFR) - When Campbell Soup came to the investment-grade bond market in March with a $5.3 billion deal to finance its acquisition of Snyder's-Lance, investor response was lukewarm.
Demand was tepid partly because some bond investors didn't believe the merger would stem a decline in sales - at least not enough to compensate for the increase in the company's leverage.
But the buyside's wariness was also driven by the soup maker's ratings.
Campbell suffered a two-notch downgrade by Moody's (to Baa2 from A3) when it more than doubled leverage to finance the deal. And with that, Campbell joined a growing number of corporates whose ratings now sit on the fringes of junk.
Leverage across investment-grade bonds globally stood at 2.6 times last year compared with 2.0 times in 2007, according to Moody's, and there's little sign that it will fall anytime soon.
"Companies have utilized a significant amount of debt to finance M&A," Jon Duensing, director of investment grade credit at Amundi Pioneer, told IFR.
"And that calls into question their ability to refinance, pay down that debt and to grow their corporate capital structure in the future."
DEBT BINGE
Corporate America's debt binge has seen the US investment-grade bond market balloon to over $6 trillion in the past 10 years from just US$2.5trn in 2008, according to data from ICE Bank of America Merrill Lynch (NYSE:BAC).
Half of that is rated in the Triple B band, leaving some investors and analysts fretting about how a recession could hit corporate earnings and tip many of these companies into junk.
"The Triple B cohort is so big that if you do have a massive recession, you could have a ton of fallen angels," said Eddie Hebert, client portfolio manager at PPM America.
"These are huge capital structures. Who is going to be the marginal buyer when these companies have to issue more debt?"
NOT ALONE
Campbell is in some ways the poster child of risks that stem from debt-funded acquisitions that then do not deliver what they set out to do.
Just three months after its bond sale, Campbell's profitability fell sharply and its CEO resigned. The bonds have widened by more than 80bp since issuance.
Moody's has threatened to downgrade Campbell again as its Baa2 rating was based on expectations of a reduction in leverage to below four times earnings in the next two years. That looks like a challenge now.
"As some of these companies borrow more to help finance these acquisitions, they're getting themselves into a position where they have less margin for error," said Duensing.
"That is really the difference between an investment-grade company and a high-yield company."
Other companies in the pharmaceuticals, consumer goods and telecommunications sectors have seen plays go awry after similarly levering up to pursue M&A.
Belgian brewer Anheuser-Busch InBev, for example, acquired SAB Miller for US$110bn two years ago. That deal boosted its leverage to more than five times earnings, according to Moody's.
At the time, senior management said it was targeting a ratio of two times over the longer term.
But instead of selling assets to pay down debt, AB InBev earlier this year sold another US$10bn of bonds to partly pre-finance debt maturities coming due in 2019 and 2020.
At the end of last year, the company had a $116 billion gross debt load and net debt/Ebitda of 4.9 times, according to CreditSights.
Analysts at the firm called the bond sale "mildly troubling", mainly because the company's deleveraging plans rest on projected improvements in earnings rather than debt reduction.
NO DISASTER YET
For now, few expect a flood of downgrades.
But over time, even if just 10% of Triple B corporate bonds were downgraded to junk, that would see around $300 billion of debt move into high-yield.
That would be more than the $275 billion of new issues the US high-yield market absorbed in the whole of 2017, according to IFR data, and could cause borrowing costs to rise if investors are unable to absorb the additional supply.
An Armageddon scenario is still seen as a stretch though.
"These companies have levers they can pull to protect their access to the capital markets and protect their credit ratings if they need it," said Duensing. "That's an important consideration as they move down the road."
That kind of confidence is allowing Triple B companies to continue to raise billions of dollars in debt.
Bayer (DE:BAYGN) (Baa1/BBB) recently slipped into the Triple B band after downgrades by Moody's and S&P because of its debt-financed acquisition of Monsanto (NYSE:MON). But it raised US$15bn through a bond sale on Monday without trouble: it got over $45 billion in orders.
Others, too, are putting ratings at risk to appease shareholders - and not just through M&A.
Starbucks (NASDAQ:SBUX) was downgraded to Baa1/BBB+ on Wednesday after it said it would increase the amount it plans to return to shareholders by 2020 to $25 billion. That's an increase from the $15 billion is stated in November 2017.
S&P said it "represents a rapid shift in financial policy while the company is experiencing a slowdown in comparable sales growth", and expects the company to raise $3 billion in debt.