Spin-offs add to high-grade woes

2014-10-11

NEW YORK, Oct 10 (IFR) - The investment-grade bond market has been slammed with another wave of bondholder-unfriendly news, with spin-off announcements from Hewlett-Packard and Symantec and activist pressure on EMC Corp to follow suit.

The three tech companies saw spreads on some of their bondsquoted anywhere from 15bp to 40bp wider this week, as investors scrambled to re-evaluate their views on the credits, while at the same time wrestling with a broad sell-off in asset classes.

The flurry of break-up news has demonstrated how rapidly the investment-grade bond market is becoming a minefield of deteriorating credits and event risk.

"We have found where new risk lies, and it's among some of the biggest names in the investment-grade market," said Scott Kimball, senior portfolio manager at Taplin, Canida & Habacht, and part of BMO Global Asset Management.

"In just the past few weeks the risk profile for eBay has materially changed, as it has for AbbVie and Hewlett-Packard."

Last week, eBay gapped out as much as 37bp on news that it would spin off PayPal and turn what is left of the company into little more than a debt-raising cash cow for shareholders.

Investors are struggling with the conflicting demands of picking credits based on fundamentals, but still needing to put record amounts of inflows to work.

Close to US$7bn poured into investment-grade bond funds for the week ended October 8, taking the year's total inflow to US$65.2bn.

At the same time, however, M&A activity, including spin-offs, is at its highest point since 2007. Investors have found themselves holding credits in an illiquid market that have suddenly gone from a good idea to a bad one.

"Companies like eBay, Hewlett-Packard and some of the healthcare names are moving away from addressing the strength of their capital structure in order to put more emphasis on corporate structure, and they're doing it even if they have to throw bondholders under the bus," said Kimball.

According to S&P there have been 57 spin-offs by non-financial corporates in the US so far this year, about a 73% increase over the 33 in 2012 and compared with 44 in 2013.

Since August last year, S&P has lowered or placed on CreditWatch negative about 30% of those companies that initiated spin-offs this year, and raised the rating on only 16% of them.

"Spin-offs often come at a price to creditors because they weaken the business profile of the parent entity or reduce cashflow without a corresponding reduction in debt," S&P wrote.

HURTFUL TIMES

Recent weeks have been especially hurtful to bonds.

Symantec's 3.95% 2022s gapped out by 40bp to 199bp on news that it intends to separate its core personal and enterprise security businesses from its storage and data back-up divisions.

EMC Corp saw its 3.375% 2023s widen about 15bp, to 130bp, after activist investor Elliott Management Corp sent its first letter to the data storage products maker, urging it to spin off its prized VMware virtualisation software unit or pursue other merger opportunities.

Hewlett-Packard's 2041s were 34bp wider at 228bp on the week after announcing it would split in two, with one half, HP Inc, holding its printing and computer businesses and the other, HP Enterprise, having the servers, storage financing and networking business.

HP was vague about key issues that would affect the credit rating of both parts. It said it wanted both new companies to be rated investment-grade, but would not give much detail on how its cash and debt would be split up.

"What we are hearing from investors is that no one really knows what the two new companies will look like and so they are hesitant right now to make a call," said Jordan Chalfin, senior technology analyst at CreditSights.

No matter how HP splits up its cash and debt among the two new entities, there are credit negatives for both, said Chalfin. "HP Inc will be focused on returning cash to shareholders, whereas Hewlett-Packard Enterprise will be more focused on M&A," he said.

Still, others also see opportunities.

Ryan Preclaw, credit strategist at Barclays, believes spin-offs can often provide investors with good investment opportunities.

"Investment-grade "RemainCo" surviving entities from spin-offs have outperformed the US Corporate index by almost 100bp in the 18 months following the announced split of their companies," he wrote recently. He sees value in HP's shorter-dated bonds such as the 2018s and 2019s, which are likely to be tendered.