M&A Waiting Game
Utilities protect their balance sheets.
the unfortunate position of needing short-term cash had to draw down bank lines of credit they had set up as a fallback. Subsequently, a number of utilities have been proactive and accessed lines of credit even though the funds weren’t needed, in order to avoid a use-or-lose ultimatum from banks.
As Stephen De May, Duke Energy’s senior vice president, treasurer and chief risk officer told Fortnightly, “We’re pre-funding our credit strategy because we don’t know if the markets will be there when we really need the capital.” 1 This was echoed by Mark Snell, Sempra’s executive vice president and CFO: “In a choppy market, you take what you can get, when you can get it.”
Doing Deals Now
One of the larger leveraged buyout deals at the moment, infrastructure fund EQT’s and Fortistar’s $525 million acquisition of Midland Cogeneration Venture, a 1,848.61-MW gas-fired combined-cycle power plant in Michigan, illustrates just how different the market for M&A is compared to 16 months—or even six months—ago. Some of these trends include:
• Struggle to fund debt issues: 16 months ago, billion-dollar transactions were not uncommon, including the largest deal ever: TXU Corp.’s $32 billion ($45 billion including debt) buyout, led by TPG and Kohlberg Kravis Roberts & Co. Prior to the credit crisis that began in late 2007, these large transactions could be financed with bank loans, where the banks fiercely competed with one another for the right to underwrite these loans. That competition provided borrowers with the ability to obtain significant concessions in loan terms. Today, finding even one or two banks to underwrite a leveraged loan is difficult. By contrast, the EQT deal was structured so that all parties can walk away from the transaction if the banks couldn’t syndicate the debt. That this deal was structured as a best-efforts syndication shows just how tight the market remains.
• High interest rates for debt: Before the credit freeze, leveraged loans used to acquire a business could be priced as low as 150-basis points above LIBOR (London Interbank Offered Rate). In the third quarter of 2008, leveraged loan spreads rose to a staggering 1,000-basis points over LIBOR. At the moment, leveraged loans spreads are between 600- and 800-basis points above LIBOR, so debt is still coming at a much higher cost.
• The collapse of the secondary leveraged loan market: One of the main characteristics of the transaction market was the easy access to bank loans to finance transactions. This trillion-dollar market was kept liquid by institutional investors such as collateral loan obligation (CLO) funds, which were eager to acquire these loans for use as collateral in issuing their own debt securities. Banks were able to quickly sell their loans to institutional investors, enabling them to continually fund new leveraged loans to new buyers. Now, the secondary market for leveraged loans has all but disappeared because the buyers of such loans have suffered staggering losses. As an immediate consequence, banks don’t have the capital to continue funding new leveraged loans as they can’t sell them.
Current conditions are having a