How a junk bond bubble is driving a buyout and merger boom

Heinz, U.S. Airways, Dell: How a junk bond bubble is driving a buyout and merger boom

"After a long fallow period in which companies were too focused on dealing with their own internal challenges to consider major acquisitions—and credit was too scarce to finance them—the floodgates seem to be opening. Some of these deals make sound strategic sense (American and US Airways are such a logical merger pairing that the deal should have happened years ago). Others are a little harder to parse (if investor Michael Dell has ideas for how the computer company could be run better, you’d think he could just go down the hallway and tell CEO Michael Dell about them).

But what many of the deals have in common is that they are being unleashed by a surge in corporate credit. The markets for bonds in even risky companies are becoming unfrozen to a degree they haven’t been in half a decade, and there seems to be some pent-up eagerness to do big deals. It’s a lot easier to make a buyout or merger work when bankers and bond investors are so eager to lend you the money to make them happen."

"But now that’s reversed! The stock market’s earnings yield is 6.6 percent, which is actually higher than the 6.1 percent that junk bonds are yielding. Buyers of junk bonds are tolerating lots of risk and not even being compensated. That suggests a market that is somehow out of whack. And there’s a quite plausible case that the Federal Reserve’s quantitative easing policies are part of the story. With the Fed buying billions of Treasury bonds and mortgage backed securities, those who would normally buy those assets have to buy something else. But it’s easy to imagine that this doesn’t affect all assets equally. Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable."