Corporate Animal Spirits Are Back and That’s Bad News for Bondholders

• January 29 2018
• Tracy Alloway

Companies are poised to ‘placate shareholders’ by relevering.

What do you get the shareholder that has almost everything? A fresh burst of corporate action aimed at boosting the value of their stock holdings even further, of course.

European companies may be gearing up for a spending spree to rival that of their U.S. counterparts in recent years, as they seek to justify increasingly lofty stock valuations -- at the expense of bondholders, according to Bank of America Merrill Lynch. On the menu: buybacks, acquisitions and spinoffs of existing units as pressure from activists intensifies, analysts led by European Credit Strategist Barnaby Martin said.

The wave of shareholder-friendly actions risks inflicting pain on bondholders asked to foot the bill, BofAML warned in research published on Monday. Such moves would mirror the corporate environment in the U.S., where many companies have attempted to offset years of sluggish economic growth by expanding through acquisition or returning more cash to shareholders.

"This credit cycle is beginning to bear all the hallmarks of the 2004-2006 era: incredibly tight spreads, patient and predictable central banks, melt-ups in risk assets and investors embracing leverage," the BofAML analysts said. "But one more phenomenon is also emerging -- pressure on corporates to gear-up balance sheets."

The median net debt-to-equity ratio for non-financial companies in Europe currently stands at 34 percent, giving ample headroom for managers to borrow from the loan and bond market to fund expansion or buybacks, BofAML said.

Moreover, stock investors have already been rewarding companies for M&A deals -- last year was the best for European acquirers since at least 2000 based on BofAML’s analysis of share price performance around the time of the announcement.

"Whatever the means of placating shareholders in 2018, though, more of this activity bodes poorly for bondholders," Martin said. "And while we don’t think it will amount to a nail in the coffin for the credit cycle in Europe -- witness how spreads treaded water a decade ago despite the LBO frenzy -- it does reinforce the selective weakening of credit fundamentals already underway in Europe."