Corporates, M&A, and Callability. As a member of the BofA/Merrill Lynch corporate 100 bond origination team, you have been working on a transaction on behalf of CVS Health Corp. (NSE: CVS) which had been planning a massive bond offering to fund the acquisition of Aetna Inc (NSE: AET). You are in charge of all the fixed-income analysis and report directly to the lead banker. A lot is on the line for your company because this deal might become the largest bond offering in 2018.
In addition to the below recent press coverage of the bond issue, you might want to consult the attached extract from the Offering Circular.
CVS Health completes world’s third-largest corporate bond sale: US pharmacy chain raises $40bn to fund purchase of health insurer Aetna
CVS Health completed the third-largest corporate bond sale in history on Tuesday, underlining the market’s ability to absorb sizeable debt issuance at the right price, despite a backdrop of rising interest rates and regulatory uncertainty. The pharmacy chain’s $40bn sale — to fund its proposed acquisition of health insurer Aetna — attracted $120.7bn of orders, according to four people with knowledge of the sale. Investors said the debt’s reasonable pricing supported the record demand, and advance notice from underwriters gave fund managers the chance to set aside cash for the offering.
Bankers and investors said the sale suggested the US bond market was comfortable with two key risks: rising yields on global government debt, and uncertainty about regulators’ approach to so-called vertical mergers, or tie-ups between companies that are not direct competitors.
CVS sold nine bonds across seven maturities to fund the deal. Most of the securities face a mandatory redemption if the acquisition is not completed by mid-2019, according to Moody’s, which assigned the debt a Baa1 rating.
Investors submitted more than $110bn of orders for $46bn of bonds issued by Anheuser-Busch InBev to fund its acquisition of SABMiller, and $101bn for the $49bn of bonds issued to fund Verizon’s acquisition of Verizon Wireless.
Spreads between yields of the new securities and benchmark government debt were mostly similar or wider than spreads offered in other large bond sales. The new five-year CVS bonds were sold at a yield of 3.899 per cent, a spread of 125 basis points over Treasuries. To compare, five-year spreads were 120 basis points in the Anheuser-Busch InBev deal. CVS’s new 10year bonds were sold at a yield of 4.475 per cent, 160 basis points higher than benchmark Treasuries, giving them the same spread as the Anheuser-Busch deal.
Some commentators have questioned the market’s resilience — investor Bill Gross, for example, in January predicted the start of a bear market in bonds. Spreads widened for the corporate debt market as a whole in February, according to ICE Bank of America Merrill Lynch indices. “We anticipate an uptick in M&A activity, so the success of today’s transaction is important to show the marketplace there is still plenty of liquidity,” said Dan Mead, head of the US investment-grade syndicate desk at BofAML.
Some bond tenors were offered with steeper-than-normal price discounts, which investors said was to compensate for the risk that regulators may block the deal. The Justice Department’s challenge to the tie-up between AT&T and Time Warner has fuelled uncertainty about the CVS-Aetna deal. However, bullishness about the prospects of the combined company fed demand for the bonds. (FT, March 06, 2016)
(a) Analyze CVS, Aetna, and the terms of the CVS offering.
• How well have CVS and Aetna been doing? What is the financing for?
• What exactly is on offer? How do the tranches differ? Present the terms of the various series in table format.
• What other debt is CVS taking on and how is it structured?
(b) Are the various tranches callable? If so, when and why? How does callability differ in this case from regular corporate callables? What are CVS trying to accomplish and what is unusual about the series’ callability?
(c) Using the attached information or any other data, whose source you would have to carefully document, critically review the pricing and terms of the debt.
• How were the bonds rated? How did the deal change CVS’ perceived credit risk and how does it influence the pricing of the bonds?
• What yields would you propose for the nine series? How should they vary with the terms of the individual tranches?
• How do price and proceeds diverge?
(d ) Research the issue and try to find out what happened. Did the final offering differ from the initial announcement and, if so, why?