News reports have indicated that 
Dell (DELL) is nearing a deal to go private in a leveraged buyout (LBO) transaction. Dell's bonds suffered heavy selling pressure as news reports have started to include additional details of a potential transaction, making the odds of a deal happening seem higher. We believe the bond market is currently pricing somewhere around a 50/50 probability of this deal happening, leaving significant downside risk.
- In general, we do think merger and acquisition activity is poised to heat up this year. Acquisition activity will probably be more weighted toward strategic deals, but the stars are aligning for LBOs to increase, as well.
- Banks' appetite for funding LBOs is increasing, as they have repaired their balance sheets and need to expand their net interest margins (which have been contracting).
- The high-yield market is wide open to new issuers and debt is cheap as all-in yields are near all-time lows.
- Private equity firms needs to put money to work before lock-up periods start to expire.
- Valuations have recovered enough that boards of directors won't feel like they are selling too low, but still offer attractive internal rates of returns to private equity sponsors.
While LBOs appear to be poised to increase, we continue to think strategic deals will outweigh financial transactions in 2013. Strategic transactions are becoming increasingly attractive to management as companies are sitting on significant amounts of cash that need to be deployed, operating margins are near their highs and will be difficult to expand further, and organic growth is difficult at best in a low-growth environment. Considering net debt leverage is generally low at most companies and debt is cheap, most issuers have plenty of bandwidth to finance deals.
Morningstar's equity and credit analysts are finishing their semi-annual merger and acquisition insight publication, in which we highlight firms that we think are takeover candidates. In this report, our credit analysts scour the bond covenants for potential takeover targets and perform upside/downside analyses to highlight bonds that are most at risk of suffering large losses in a LBO scenario, as well as identify those bonds that may improve from being acquired by a larger, investment-grade company. We anticipate publishing our next instalment later this week.
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