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AbbVie’s $63 Billion Mega Deal Returns Focus to Debt-Fueled M&A

Molly Smith

(Bloomberg) -- AbbVie Inc.’s $63 billion deal for Allergan Plc will take the company’s debt burden to a level that can rival some junk-rated companies.

But both Moody’s Investors Service and S&P Global Ratings are giving the drugmaker the benefit of the doubt in its ability to quickly slash as much as $18 billion of its borrowings. Moody’s signaled it will leave its rating on AbbVie unchanged at Baa2, or two notches above speculative-grade. And S&P said it’s likely to lower its grade one level to BBB+, a step higher than where Moody’s rates the drugmaker.

Credit investors aren’t exactly penalizing companies for taking on such debt, either. While AbbVie’s relative borrowing costs increased in trading Tuesday after the deal announcement, companies rated in the lowest tier of investment-grade are paying some of the lowest premiums ever to borrow. Even those companies that tip into junk territory pay relatively little in extra yield.

Why? One clue: investors who’ve bought lower-rated debt are being rewarded with some of the best returns in years.

“Companies have been given the green light to use a lot of leverage,” said Travis King, head of investment-grade credit at Voya Investment Management. “Debt is cheap so it makes sense from their perspective, and rating agencies are giving them the OK to do that.”

Both Moody’s and S&P estimate that the Allergan transaction will push the company’s debt to at least four times its earnings before interest, taxes, depreciation and amortization (Ebitda). In presentations Tuesday, though, AbbVie said it plans to reduce its debt load by as much as $18 billion by the end of 2021. That should cut leverage to about three times Ebitda within two years of the deal’s closing, the ratings firms said.

The assumptions underscore a consistent theme in the corporate bond market over the past decade, in which companies have loaded up on relatively cheap debt for acquisitions. While they often sacrifice pristine credit ratings in the process, stable cash flows and the promise of big savings from the mergers have allowed them to keep their ratings in the BBB tier, the lowest rung of investment-grade. More than half of the $5.6 trillion investment-grade bond market is now rated in that tier.

Even so, BBBs have been among the best performing assets in fixed income this year, boasting returns of nearly 11% that have outpaced gains on debt issued by speculative-grade companies, data compiled by Bloomberg show. Investors are reaching for higher-yielding assets thanks to the Federal Reserve’s signals that it’s willing to cut interest rates to sustain the economy.

“This is the product of a rate environment that will encourage companies to use debt to achieve their strategic goals,” said Scott Kimball, a money manager at BMO Global Asset Management in Miami.

Read more: A $1 Trillion Powder Keg Threatens the Corporate Bond Market

Investors have flagged the potential for a wave of downgrades to junk should the economy worsen, and some say the ratings firms are cutting companies too much slack. Anne Walsh, chief investment officer of fixed income at Guggenheim Partners, said last week that credit raters have baked in too much confidence in BBB companies’ ability to delever even though it’s “not realistic” in a recessionary environment.

Plenty of market participants said Tuesday that AbbVie’s debt-cutting plans are entirely plausible.

“For better or worse, the ratings agencies must take, in good faith, management’s deleveraging goals as part of these debt-financed mergers, said Mike Holland, a Bloomberg Intelligence credit analyst. “This merger would create a company with substantial free cash flow such that a debt reduction target of $15-$18 billion by the end of 2021 is not unreasonable.”

--With assistance from Natalie Harrison and Katrina Lewis.

To contact the reporter on this story: Molly Smith in New York at msmith604@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Shannon D. Harrington, Allan Lopez

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