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New High Yield Deals

8 September 2016 by Felipe Villarroel

September is here, which for fixed income managers usually marks the return of the new issue season, as addressed in our previous blog Will September See The Primary Market On Fire. In contrast to what we have seen in European investment grade markets, high yield new issuance activity has been rather muted, with only a couple of deals pricing last week. Yesterday we saw a lot more activity, mostly from well-known issuers.

Two of them caught our attention and prompted an interesting discussion on the desk about the stage of the credit cycle. Ardagh Glass priced a $1.56 billion equivalent PIK Toggle Note deal in euros and dollars while Schaeffler announced a €2.5 billion equivalent PIK Toggle deal.

These deals are holding company, or “HoldCo” issued, meaning the deals are issued by entities sitting outside the restricted group of senior secured and senior unsecured bondholders (Ardagh’s HoldCo entity is called ARD Finance S.A. whilst Shaeffler’s is IHO Holding). In addition, the PIK Toggle feature allows the issuer to pay coupons in kind, either in cash or by issuing more bonds. What this means is that PIK bondholders are essentially lending money to shareholders of Ardagh/Shaeffler, in this case who use their shares in those companies as collateral. Because the issuer of the PIK is a HoldCo whose only assets are shares in Ardagh/Shaeffler (and also shares in Continental in the case of IHO Holding), the ability of the issuer to pay coupons in cash depends exclusively on dividends streamed from these equity investments. For this reason they need to have the option of paying the coupon in kind rather than in cash and they sit at the bottom of the consolidated capital structure.

These deals caught our attention for different reasons. In the case of ARD Finance the new issue will refinance all existing PIK notes but will also be used to pay a €270 million dividend to shareholders. Consequently leverage at the HoldCo level will increase from 6.3x to 6.5x (with EBITDA including synergies of a recently closed acquisition). We have long been supporters of Ardagh’s story and fundamentals and this transaction doesn’t change that. We were left wondering however if this is the quiet start of a later stage of the credit cycle in Europe. Companies raising debt to pay themselves dividends or buy back their own stock happens more often in later stages of the cycle. Although this is only an isolated case at the moment we will be closely monitoring new high yield deals to assess if this is the start of a trend. In the case of IHO Holding, the new PIKs will refinance all existing PIK notes and also form part of an intercompany loan given by Shaeffler to IHO Holding, with no dividends involved.

On a separate note, we think it’s worth noting that in the space of two days the HY market was able to absorb close to €4 billion of PIK notes at yields that look very attractive for issuers, with heavily oversubscribed books and with one of them being used in part to pay shareholders a dividend.

The market technicals caused by the various QE programmes are clearly still very strong.

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