* M&A activity tipped to pick up with LBO prospects
* Change-of-control language still relatively rare
* Small and medium sized corporates most likely targets
By Natalie Harrison and Josie Cox
LONDON, March 8 (IFR) - Investment-grade bondholders mayfind themselves unprepared and at the centre of an event riskminefield if cash-rich corporates and private equity firms,encouraged by a sustained equity rally, embark on an acquisitionspree.
After a dismal two years for M&A activity, bankers arehopeful that two to three mega leveraged buyouts - reminiscentof the 2006-2007 leveraged buyout boom - could materialise inEurope in the second or third quarter, with each involvingEUR10-15bn of debt,
But while this is good news for fee-hungry bankers, it's achilling prospect for some high-grade bondholders.
Britain's biggest mobile operator Everything Everywhere andFrench media giant Vivendi's SFR mobile unit have emerged astargets, and there are plenty of potential buyers.
Vodafone, for example, has been linked to cable companiesONO, Kabel Deutschland, and Yoigo in the past few weeks, and hasalso shored up its funds via a huge USD6bn bond issue in recentweeks.
Rating agency Moody's warned on Thursday that the proposedUSD23.2bn buyout of U.S. food giant Heinz by Warren Buffett'sBerkshire Hathaway and 3G Capital could leave some Heinzbondholders in a far weaker position in the company's capitalstructure.
Almost USD900m of Heinz's current USD4.3bn of outstandingbonds will remain in place after the deal closes, and could bejunked due a doubling in leverage, Moody's said.
"The deal is a reminder to investment-grade bondholders thattheir often minimal covenant protection can leave them exposedto a sharp decline in value after an acquisition is announced,"said Moody's analyst Alexander Dill.
"It also illustrates the particular importance ofchange-of-control provisions in bond covenants, though thesewere less common in investment-grade indentures before theleveraged buyout boom of 2006-07."
Despite clear signs that takeovers are picking up, only 37%of high-grade non-financial issuance documents containedchange-of-control protection clauses last year, according toBank of America Merrill Lynch data. So far this year that numberhas fallen to 31%.
Among recent investment-grade issuers that have includedchange-of-control language are German auto parts supplier HellaKGaA Hueck & Co and Everything Everywhere.
Spanish conglomerate Abertis Infraestructuras, however, didnot, and sold a EUR750m seven-year bond on the back of EUR4.5bnorders, despite in 2010 having been at the centre of takeoverspeculation.
TAKING A LIBERTY
Change-of-control covenants will put a floor on the value ofa security - usually 101 - but this still leaves investorsexposed if the bonds are trading well in excess of that level.
Liberty Global's acquisition of Virgin Media last month, forexample, resulted in a 12-point drop in the price of thelatter's 2021 investment-grade rated secured bonds.
"In the high-yield market event risk is typically positive,as you are more likely to be taken over by a company that ishigher rated than you, but in the investment-grade market,negative implications can be significant," said James Gledhill,investment fund manager at AXA IM.
Identifying acquisitive companies, by looking at their cashholdings and liquidity, is quite straightforward. The problemlies in identifying who might be the targets, investors say.
In high-yield, it tends to be the most cash-generativecompanies, but Virgin Media bondholders clearly didn't seeLiberty coming.
The Heinz deal and Dell's USD24bn buyout are the firstproposed leveraged buyouts worth over USD10bn since thefinancial crisis, and the odds are that the pace of takeoverswill quicken in Europe.
"Capital markets bankers are telling us that there will be alarge amount of leveraged loans coming our way. There's usuallya three-month time lag from the bid to financing, but the thirdand fourth quarters could be busy," said one leveraged loaninvestor.
"Bankers are certainly saying that this is the busiest theyhave been in three years."
Corporate confidence is clearly on the rise too.
"We are...open to small and medium sized acquisitionopportunities to achieve this aim of diversifying from mobile tofixed line," Hans Tschuden, chief financial officer of TelekomAustria told IFR.
Leveraged financiers are saying there is a lot of gung-hoM&A talk and banks are conducting discussions on underwriting.
"The Liberty Global Virgin Media deal got everyone excited.The fact is there has been a relative lack of supply, and thatis pushing people to be more ambitious."
Vodafone (VOD)
