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Chasing the Money, Cheap Money

While investment bankers spent the second half of 2002 trying to talk up a recovery in the equity markets, the corporate bond business has been quietly staging a comeback, and looks poised to underpin company funding requirements in the coming months.

Rights issues are as dead as the dodo with little sign of activity in that market with equity prices at their current levels. It simply requires issuing too many shares to raise an adequate amount of cash. “However, there has been a reasonable amount of bond activity,” says Trevor Pitman, managing director at rating agency Fitch. “On the one hand, people say that companies are cutting back on capital expenditure and the gloomy scenario doesn’t encourage them to come to the bond market. But, there is another factor which indicates that there has been a postponement of activity, and corporates may now be reactivating their borrowing plans. If the corporate bond portfolio is yielding 6% on investment grade that is quite a positive fixed-income return. And the bond market is proving more stable than had been thought.”

Traders are now talking about a “de-coupling” taking place between equities and corporate bonds. Five or six months ago, the Iraq war scenario and a total lack of consumer confidence were pushing corporate bond spreads to record levels, with investors fleeing to safer havens. But this link between equities and bonds is softening, particularly because investors are now realising that falling stock markets have no correlation to corporate fundamentals.

Many corporates are finding it difficult to attract investors and they are wondering about the value of the markets if they can’t be used for raising funds. “Corporates are very frustrated,” says Mark Gillespie, a partner in Deloitte Consulting’s corporate advisory team.

“Companies with nice businesses, a sensible management team and no corporate trip-ups are not confident about their ability to do deals that require equity. The trend is for mid-caps to be out of favour.”

Fitch’s Pitman points out that the agency is currently working on one or two ratings that suggest companies will be back tapping the bond market in the not-too-distant future. “Investors will look across the scale and do a stringent credit appraisal after the past 12-to-18 months of turbulence,” he says. “They will look at solid industrial corporates with perhaps a little bit too much debt on their books. This will be in the solid business areas and not highly leveraged telecoms, for instance.”

But bond issuance is not the only market that corporates are looking at to raise cash.

It would be naive to assume that because some of the global investment banks have shown themselves willing to go down-market to meet smaller issuers’ needs, that they really mean what they say. There is little point in any mid-cap trying to build a relationship with Goldman Sachs or Morgan Stanley. They will be gone as soon as the markets stage a turnaround, simply because with the cost structures they carry, in normal times they cannot make any money on a #300m deal.

As for syndicated lending, to give them their due the banks have been sticking at it, providing debt capacity in tricky times. They’re taking a more cautious approach these days, but we haven’t yet seen a knee-jerk reaction of pulling credit as occurred in the recession of the early 1990s.

However, the rising star is another area of financing, and there is a prevailing view that this year will see a lot more PTP (public-to-private) transactions. “The level of corporate activity has dropped sharply and the view is that it’s not coming back this year,” says Deloitte’s Gillespie.

“But people are reconciled to current prices so mid-cap corporate activity is likely to pick up, as institutions are willing to sell.”

Money is burning a hole in people’s pockets – look at Philip Green and his multiple retail forays. Investors are aware that pricing has come back as an issue. With the falls that have taken place in the past 12-to-18 months, a lot of FDs will be looking at ridiculously low multiples of potential target companies. They will be concerned largely about the next year or so, asking themselves if they can make an acquisition without stepping on any banana skins in the unpredictable next year or so, and they are less worried about the medium term.

Bonds are staging a comeback, while private equity looks set to become the flavour of the year. In fact, it now accounts for about half of all M&A activity in the UK. The money is there and a number of UK corporates are quite explicitly saying they are comfortable with their 2003 figures.

Given a chance, they will borrow, and they will buy.

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