Junk Bonds in LBOs
I don't understand why you would Junk Bonds in LBOs if the target has good free cash-flow? Are Junk Bonds still common?
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Assuming that the company has a solid business risk profile, LBOs are still going to be financed through the below investment grade ("junk") market due to the significant amount of leverage/financial risk that they entail. You don't get 6 turns of leverage through unsecured IG debt.
But if the company's cashflow shows that it can service the debt, why do the bonds need to be Junk?
There's potential risk behind the transaction because your uses of funds aren't necessarily based around your core competencies. Say you went to market to issue some debt for working capital, for the most part you're going to get reasonable rates because the debt is backed by the business function your company thrives on to exist and the financing is short term. No company "thrives" of an acquisition, it is inorganic in a sense thus investors require a much higher yield for this type of debt. You also have to realize that you're issuing long term debt for acquisitions, and investors always require higher yields because of the uncertainty caused by inflation, interest rate risk, and market risk. You also have to understand that you'd have to issue a corporate debenture for this type of transaction. Debentures are unsecured, and companies default on them all the time hence the reason why they're high yield securities. Hope this gives you some insight.
When Barclays acquired ABSA if they used debt say, why would it be junk? Barclays was doing incredibly well hence Barclays wanted a piece of the pie.
It doesn't sound like good Risk Management to issue junk for all acquisitions , surely cases should differ
Again, read my comment above. I don't think you're fully grasping how bond pricing works. I would recommend picking up a book on fixed income, and after reading you would understand why acquisitions require high yields. Company's/Banks don't determine yield on bonds, the market/underwriter does.
You are 100% right i know i don't understand bond pricing...book suggestions?
Bodie Kane is probably going to best book you'll find, and my personal favorite. It's what sparked my interest in debt, and why I'm where I'm at today. It gives a great foundation for understanding fixed income fundamentals. And equity/option pricing as well.
I understand equity and options very well but very rusty on debt. Thanks
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