C.M.O. 3.9.2010
Credit Market Overview
March 9, 2010
In solving most white color crimes the key to finding the culprits is following the money. While in no way suggesting such nefarious goings on, it is quite useful to apply this tactic to Wall Street when trying to determine where the strength and weakness might be across various business lines and asset classes.
In early February Barron’s interviewed Roger C. Altman, CEO of Evercore Partners. The part of that Q&A most germane to today’s theme was this “A” that came after one of Larry Strauss’s “Q’s”: “Historically, you see that the upcycles last five to eight years, and the downcycles typically two to three years. We have just come through more than a two-year down cycle, and it is clear to me that we have turned the corner.”
This view was bolstered when it was reported last week that when data from Capital IQ was analyzed by the WSJ it was found that the 382 non-financial firms in the S&P 500 were sitting on top of $932BN in cash and short term securities. The answer to the question of what to do with all that dough has been in part supplied by the fact that stocks are still trading about 27% below their 2007 highs.
The result is best exemplified by Walgreen’s (WAG) $618MM cash bid for Duanne Reade (Private). Wade Miquelon, CFO of WAG reasoned it this way: “We are sitting on a lot of cash and generating a lot as well, sitting around on all that cash and have it earn very little really does not make a lot of sense.” Wade went on to say, “We are conservative with our cash, but hoarding it right now isn’t probably the best use of it.”
Like the WAG deal, cash does seem to be king at the moment, or at least the preferred method of acquisition as through 2/28 the percentage of cash deals in the U.S. more than doubled from the same period in 2009 according to Thomson Reuters with 50% of this years deals being paid for outright vs. about 24% in 2009.
The activity appears to be stretching across wide swaths of the economy as India’s Essar Group just agreed to fork over $600MM greenbacks to buy U.S. coal producer Trinity Coal from U.S. based P.E. firm Denham Capital. Additionally, while not the major thread of this morning’s monologue it should not be lost that there is increasing demand by the world’s fastest growing economies (India and China) to lock up supply of the raw materials those countries need to continue their growth.
Coal is used is used in those industries where a lot of heat needs to be generated and the two that come most quickly to mind are energy and steel. That second use is adding more fuel to the M&A fire as Wayzata Investment Partners, a P.E. firm has been quietly acquiring small foundries across the U.S. in places like St. Cloud, Minn., New Castle , Ind. and Iron Mountain, Mich. While the deals are not big ($70MM for Grede Foundries in St. Cloud) the folks at Wayzata believe the resurgent economy will make foundries a “hot” investment. In support of their idea the national trade group for America’s foundries is quick to note that 90% of man-made products in the U.S. contain a part made in one of this or another country’s 2,100 foundries.
For proof of the “other country” part of that last statement we need to look no further than two of the grand pillars of the private equity business Kohlberg Kravis Roberts & Co. and TPG Capital who appear close to inking a deal to buy Morgan Stanley’s stake in China Capital Corp. If successful KKR and TPG would split MS’s current 34.3% stake in CICC with Henry Kravis and David Bonderman, founders of their respective firms, gaining seats on CICC’s board.
Needless to say none of this activity would be going on if all of the very smart people involved in these deals didn’t believe the outlook for the world’s economy was more positive than negative. It is also worth being reminded that bids, whether they come from another company or a P.E. firm, are usually at a premium to current market prices in order to entice holders to surrender their stakes. As such M&A activity is usually not a bad thing for anyone lucky enough to own part of a target company or for stocks in general.
Investment grade CDS spreads continued lower yesterday closing at 83bps. That level was last seen on Jan 10th of this year while spreads were on their way up to their 106bps peak on 2/8.
High Yield spreads closed at 519bps yesterday which matched the 1/20 close, which like IG spreads, were on their way higher at the time cresting at 637bps on 2/15.
In the period leading up to the market’s highs in October of 2007 M&A deals were paid for with heaps of debt which was used to pay the acquirers huge upfront dividends. The current mode of cash acquisitions leaves the acquisitors with a lot more skin in the game. Needless to say, if you follow the money, this should lead to more careful corporate stewardship.
As for Mr. Altman’s view on the prospects of M&A, all we can say is roger, Roger.
Enjoy the week.
Jim Delaney
