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Bond Strategists: Buy London Stock Exchange Debt, Barclays Says
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By Sebastian Boyd
Nov. 24 (Bloomberg) -- A takeover of London Stock Exchange Plc is likely to benefit holders of its bonds because the securities reward investors for any deterioration in credit ratings, Barclays Capital says.
Nasdaq Stock Market Inc. and buyout firms have built equity stakes in the U.K. exchange. A takeover by either could cause LSE to lose its investment-grade credit ratings because Nasdaq is rated high-yield, high-risk and a private-equity deal would be financed by loading the company with debt.
When LSE sold bonds in July, Nasdaq had already said it wanted to buy the U.K. bourse and the borrower included terms to protect investors. Interest payments on the bonds will rise by 25 basis points every time Moody's Investors Service lowers its ranking of the company's credit worthiness. If the rating falls to non-investment grade, or junk, the coupon will increase by 1 percent.
``The bonds are really cheap,'' said Puneet Sharma, a credit strategist in London at Barclays Capital, which has a ``buy'' recommendation. ``These days the risk of a takeover leading to a downgrade is substantial, so people are pushing for protection on bonds.''
`Negative Pressure'
Moody's has indicated it may cut LSE's ratings after a successful takeover by Nasdaq, saying on Nov. 20 that ``negative ratings pressure'' would be likely.
The yield premium, or spread, investors demand to buy the LSE's 250 million pounds of 5.87 percent bonds due in July 2016, compared with similar-maturity U.K. government debt, is 119 basis points.
Moody's Investors Service rates the bonds Baa1, the eighth- highest of 10 possible investment grades. Should Moody's cut the rating the spread would rise by between 10 basis points and 30 basis points. The bonds would return between 200 and 300 basis points more than government debt, according to Barclays' calculations. A basis point is 0.01 percentage point.
Moody's gives Nasdaq a non-investment grade ranking of Ba3, five steps below the London exchange, and three steps below investment grade. Standard & Poor's rates it BB+.
High-yield, high-risk bonds are rated below Baa3 at Moody's and BBB- at S&P.
Were Moody's to cut its rating on LSE in line with its rating on Nasdaq, investors would earn between 300 and 450 basis points more than government bonds, Barclays said.
``If the coupon steps up, the spread will initially widen to keep the price the same, but will then come back in,'' Sharma said.
Stake Building
Nasdaq has amassed 29 percent of the U.K. exchange and said on Nov. 21 it will take its offer directly to LSE's shareholders after the British bourse rejected the bid. LSE, which refused to meet Nasdaq executives for talks, said the U.S. exchange's 2.7 billion-pound ($5.2 billion) offer is too low.
Hedge fund investors, led by corporate raider Samuel Heyman, are also buying stakes in LSE. Heyman, acquired 8.8 percent of the exchange through derivatives including a total return swap and contracts for difference, paying as much as 3.8 percent more than Nasdaq's 1,243 pence-a-share offer, according to regulatory filings. GLG Partners, which controls about 1.3 percent of LSE through derivatives, paid as much as 1,275 pence, the filings show.
Leveraged buyout firms raise investor concerns because they buy companies using a little of their own money and typically borrow to pay about two-thirds of the purchase price. The result is that bond prices and credit ratings fall and spreads widen.
Investors are unlikely to sell, or put, the bonds back to the borrower, Sharma said. ``You'll be able to make a substantial profit on the price, so a put is likely to be excluded,'' he said.