Takeover artists may not have junk bonds in their bag of tricks anymore, but some market players are still queasy about high-grade corporates' old nemesis: event risk.
While acquisition financing has dried up in the past two years -- and with it much of the 1980s merger mania -- the threat of takeover-inspired shocks to corporations' credit standing still haunts the corporate bond market.
Just last month, Kohlberg, Kravis, Roberts & Co., which engineered the 1989 leveraged buyout of RJR Nabisco Inc. and proved even Corporate America's biggest fish could be reeled in, announced it had raised $1.5 billion for potential acquisitions, bringing its war chest to $3 billion. Although few Wall Streeters say mergers and acquisitions will relive its glory days any time soon, developments such as KKR's growing pool of cash have gotten some bond buyers thinking.
"It's widely held that event risk is dead, but we liken it to a virus in in its dormant phase," says one Midwest fixed-income manager.
Back in the 1980s, the takedown of corporate Goliaths made industrial bonds anathema to many bond buyers. That drove up the risk premium the market demanded from corporations perceived as potential targets.
And bond buyers suffered greatly at the hands of leveraged buyouts: two out of every five investment-grade corporate bonds prone to event risk were downgraded between 1986 and 1989, costing bondholders about $2.9 billion over the four-year period, according to Salomon Brothers Inc.
Now, "there may be isolated instances [of acquisitions] coming up, but if it's widespread you're going to have spread movements," says Richard S. Barnett, industrial analyst at Mabon Securities Inc. For example, "some triple-B companies traded at junk spreads" months or even a year before a takeover or recapitalization back in the go-go 1980s.
Cecil Wray Jr., partner at Debevoise & Plimpton, says, "What caused a lot of the flap about event risk protection was public bonds which didn't have a lot by way of covenants, so somebody could take control of a company and leverage it up to the eyeballs."
"People are still concerned about changes of control," Mr. Wray said, noting that many deals -- especially those in the private market -- carry some type of event-risk protection.
To be sure, merger and acquisition activity has all but fallen off a cliff in the past 18 months as the new-issue junk bond market withered and commercial banks tightened their fists.
According to Securities Data Co./Bond Buyer, just 394 announced deals totaling $17 billion have been completed or are pending this year, down from 478 deals totaling $30.6 billion for the same period in 1990.
With such a falloff -- and a shift to strategically driven deals -- Moody's Investors Service cut the ratings of just 28 companies affecting $15 billion of debt because of event risk last year. That was down sharply from 77 downgrades affecting $50 billion in 1989.
Still, "I would say event risk is still a problem," said Glenn Henricksen, portfolio manager at New York Life Insurance Co., though "it's not just going to be guys coming and releveraging companies and taking them way down the credit specrum."
Mr. Henrickson noted that the Wall Street rumor mill includes speculation that Hanson Trust's purchase last month of a 2.8% stake in Imperial Chemical, which has outstanding bonds, could lead to a new megamerger.
"These guys have issued over here and boom -- Hanson comes in and buys them," Mr. Henricksen said. "I would imagine it would definitely be a negative for a company like that, and people are going, 'Oh no, not this again.'"
Talk of other possible acquisitions -- including Campbell Soup Inc. by Philip Morris Cos., McGraw-Hill by Paramount, and Potlatch by International Paper -- has also circulated.
This year has already seen its first megadeal, with the $7.4 billion acquisition of NCR Corp. by American Telephone & Telegraph. If the Securities and Exchange Commission approves the financing plan, the deal will be effected through an equity swap -- and bondholders will walk away unscathed. But if the SEC approval is not granted, only 60% of the financing will be equity.
"Event risk is a disease that hits creditors ... and the harm to bondholders comes when they use a lot of debt for these transactions," said Gail I. Hessol, managing director at Standard & Poor's Corp. "I still do not see banks lining up to finance highly leveraged transactions ... and while there have been a couple of junk bond issues in the last few months, the wildly leveraged deals you saw in 1987 aren't happening now and I wouldn't expect them this year."
All in all, "I don't see it as a big near-term threat," she said. "But if I were buying bonds today, I would still be concerned about a company buying back its stock or doing a big acquisition sometime during the time I owned the bonds. I think it's still worthwhile to have some kind of protection, even though the danger might not be this quarter or this year."
Despite the falloff in business, M&A bankers are hopeful given the brightening economic outlook.
"Obviously the financing environment is very different, but I think this year's going to be a little better" than 1990, said Robert Hastings, head of M&A at PaineWebber Inc. As for a junk bond-financed deal: "I wouldn't rule it out for 1991."
But "one of the most noteworthy things that has happened is the fact the public market valuations have gotten quite high, relatively speaking," Mr. Hastings said. "If you can sell a business for $100 but can take it public for $125, obviously that's going to have an impact."
Lured by a rally on Wall Street, U.S. corporations sold a record $7.3 billion of new stock in May and could set a new record by the end of this quarter, according to IDD Information Services.
Junk bond players, meanwhile, are still adjusting to an anemic new-issue market that so far has no place for buyout financing.
"In the minds of many people, high-yield bonds equal leveraged buyouts which equal hostile takeovers," said Martin S. Fridson, director of high-yield research at Merrill Lynch & Co. "But just last week we did Chiquita, and that's a different kind of high-yield bond."
Chiquita Brands International recently followed RJR Nabisco back to the high-yield market with $200 million of subordinated notes in the second high-yield offering this year. Chiquita, best known for marketing bananas, is using the proceeds for general corporate purposes -- not to finance acquisitions.
Just two other companies, Johnston Coca-Cola and Dr Pepper/Seven-Up, have high-yield offerings in registration.
"During the course of the 1980s, new-issue volume went from $1 billion a year to $1 billion a year -- but, of course, went to $30 billion a year in the interim," Mr. Fridson said, noting, "high-yield bonds are not dead, but I don't think you have the conditions to do LBO-related issuance."
Meanwhile, "you could continue to issue RJRs and Chiquitas and Johnston Cokes ... and have high-grade bonds go merrily on their way," he said.
In Friday's market, a steep yield curve continued to lure corporate issuers to the intermediate sector despite 1/4-point losses in the secondary market.
While the yield on the bellwether Treasury has long been stuck above 8.20% in recent weeks, the three- to five-year sector has attracted corporate treasurers' attention.
Among the more than $500 million of short and intermediate paper to hit the market was a $250 million 10-year issue from Phillips Petroleum. A Morgan Stanley & Co. team priced the noncallable securities as 9s at par to yield just 97 basis points over the Treasury curve.
Moody's Investors Service rates the issue Baal; Standard & Poor's Corp. rates it BBB.