The new M&A – mergers and asset sales
admin | March 29, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
After a few years of gorging on large acquisitions and stretching balance sheets in an effort to post growth, management teams seem to be shifting gears. As noted in the APS 2019 Outlook, balance sheets and strong credit profiles would likely be a catalyst for positive credit spread momentum in 2019. While credit spreads have moved tighter since the start of the year, outperformance has occurred in names with pristine balance sheets, such as Best Buy (BBY), or companies that are delivering on debt reduction since closing large acquisitions, like Conagra (CAG). However, the most recent round of earnings calls marked a shift in how management teams are viewing the balance sheet, with more teams considering asset sales in addition to cash flows to reduce leverage after large acquisitions. These assets sales are likely to provide the next catalyst for credit outperformance. Credits that could outperform peers as they execute asset sales to repay debt include AT&T and Constellation Brands.
AT&T Inc. (T – Baa2/BBB/A-)
Debt reduction is a top priority after the close of the Time Warner Entertainment deal. AT&T management is looking to execute roughly $6 to $8 billion of asset sales, focusing on real estate and other non-core assets, in an effort to accelerate debt reduction. This is in addition to the $12 billion of free cash flow (after dividends) that the company is forecasting to generate in 2019 and will use to delever. Based on estimates of $60 billion of adjusted EBITDA for the year, management believes it can reduce net debt to the $150 to $152 billion range, bringing net leverage to management’s 2.5x target range by year-end 2019.
As management reduces debt in a meaningful way, AT&T bonds could outperform peers, particularly VZ, in 2019. The largest catalyst for the outperformance of T bonds will be management’s ability to execute the aforementioned asset sales, which are imperative in getting to the approximate $20 billion of debt reduction in 2019. Management’s willingness to shed assets to further reduce debt demonstrates their commitment to the leverage target. With $13.2 billion of term loans outstanding coupled with $6.8 billion of debt maturing in 2019, including TWX’s $650 million maturity in June, AT&T can successfully hit its debt reduction target without the need for a tender offer.
Constellation Brands Inc. (STZ – Baa3/BBB)
STZ funded its increased stake in Canopy Growth Corp. with debt, bringing leverage up a turn to 4.6x. At the time, management noted that they would use free cash flow to reduce leverage to its target of 3.5x within 18-24 months from the close (11/1/18). Management’s commitment to the leverage target coupled with its ability to hit the target by halting share repurchases and acquisitions staved off a downgrade by Moody’s. However after posting fiscal 3Q results that highlighted further weakness in the low end wine portfolio, STZ noted that they would be looking to divest some of the labels in an effort to return the portfolio to growth and deliver higher margins.
STZ stated that any asset sale proceeds will be used to repay debt and hit the leverage target before returning cash to shareholders. Coupled with strong free cash flow of over $1 billion in 2019, management now believes they can hit their leverage target within 12 months versus previous expectations of 18-24 months. Estimates are that STZ will need to repay roughly $3.0 billion of debt to hit its leverage target. With $1 billion of debt maturing in 2019 and just shy of $2 billion of term loans outstanding, STZ may also be able to hit its leverage target without the need of a tender offer. Most recently it has been reported that STZ is in advanced talks with E. & J. Gallo for some of the brands, which could fetch approximately $2 billion in proceeds. While STZ is currently trading about 5 bp through higher rated ABIBB (Baa1/A- (*-)/BBB), their acceleration of debt reduction from asset sales should fuel further outperformance in the name. ABIBB has yet to reduce debt in a meaningful way since the close of the SAB Miller acquisition (10/10/16) and leverage could remain above 4.0x past 2020.
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