Bonds backing CVS Health (NYSE: CVS) are leaning wider this morning after the company’s Sunday confirmation of a blockbuster $77 billion, debt-financed deal to merge with Aetna (NYSE: AET), though the bulk of the move wider for bonds took place over the last week in anticipation of the formal M&A announcement, trade data show.
The debt portion of the financing would be among the heftiest ever attempted. CVS today on the M&A call said the company would look to place $45 billion of new debt and draw on cash on hand to finance the merger, which is slated to close in the second half of 2018, pending shareholder and regulatory approvals. The definitive agreement values Aetna shares at roughly $69 billion, and the $77 billion transaction price includes the assumption of Aetna debt. Barclays, Goldman Sachs, and BAML are providing $49 billion of financing commitments, according to CVS.
The biggest single debt offerings on record remain the $49 billion, eight part deal placed by Verizon in September 2013 for its acquisition of Vodafone’s stake in Verizon Wireless, and the $46 billion, seven-part deal placed by Anheuser-Busch InBev in January 2016 for its SABMiller buy. AT&T in July this year placed $22.5 billion of notes, or the third biggest offering on record, and the anchor piece of a $40 billion debt-financing package backing its now-imperiled bid to merge with Time Warner.
CVS, now a decade out from its transformative acquisition of Caremark, in 2015 placed $15 billion of notes backing its $12.7 billion acquisition of Omnicare and $1.9 billion acquisition of Target’s pharmacy and clinic businesses.
CVS 5.125% bonds due July 20, 2045 led the charts for trading volume this morning, changing hands at a weighted average of T+172, from T+170 on Friday and T+161 one week ago. The bonds lurched wider from T+133 after press reports on Oct. 26 tipped the advanced merger talks.
Meantime, Aetna 2.75% notes due 2022 traded this morning at T+88, or only a few basis points wider week to week, but up from trades at T+54 ahead of the revelation of M&A ambitions late last month.
Five-year CDS debt-protection costs actually ebbed this morning by three basis points, to a reading near 65 bps, according to Markit. The close on Friday at 68 bps was the high-water mark since The Wall Street Journal broke the story on Oct. 26, reflecting a move up from 50 bps on Oct. 25. Aetna five-year CDS was steady today near 39 bps, but was up from 26 bps on Oct. 25.
CVS carries BBB+/Baa1 senior ratings at present, while Aetna is rated A/Baa2/A–.
S&P Global Ratings and Moody’s today placed their rating on CVS under review for possible downgrade, but both noted that they expected any cut to be limited to one notch. Both agencies also affirmed their respective Tier 2 short-term commercial paper ratings, on a view that the combined entity would retain strong liquidity and would target rapid deleveraging under a proposed prepayable capital structure.
Notably, both CVS and Aetna today announced that they would suspend share buybacks as of today to enable post-M&A debt reduction. CVS repurchased more than $4.8 billion of its shares over the 12 months to Sept. 30 this year, while Aetna bought back nearly $3.9 billion over the same span, according to S&P Global Market Intelligence.
S&P Global Ratings expects adjusted debt to EBITDA to lurch up to 4.5x–4.8x pro forma for the closing of the transaction—from 3.2x for the LTM period to June this year—and to remain above 4x for more than a year.
CVS’ own leverage targets are for 4.6x at closing, the mid-3x area two years post the closing, and the low-3x range ultimately, with rapid debt pay-down a priority in defense of the commercial-paper ratings. The companies also intend to maintain existing capitalization structures at the insurance subsidiaries in defense of their investment-grade profiles.
“The combination of CVS and Aetna will create a one of a kind vertically integrated healthcare company with huge scale and mark an industry shift towards a more seamless approach to managing healthcare costs as it brings together the overall management of a patient’s medical bills and prescription drugs under one umbrella”, said Moody’s Mickey Chadha in a research note. “However, the transaction will result in significant weakening of CVS’ credit metrics as it will be financed with a large amount of debt and will come with high execution and integration risks.”
Additional factors in the Moody’s downgrade review include the CVS’ exclusion from two new restricted network relationships between Walgreens and Prime Therapeutics, as well as between Walgreens and the Department of Defense Tricare program; reimbursement rate pressures, and weak front-end sales, which will exert drag on CVS earnings over the medium term, the agency noted.
Consideration for a deal would be in the context of Aetna’s $58.9 billion enterprise value at the start of the quarter, which included more than $9.1 billion of total debt and $3.6 billion of cash and equivalents, according to S&P Global Market Intelligence. CVS carried a total enterprise value of more than $101 billion into the current quarter, including $26.8 billion of total debt and $2.2 billion of cash and short-term investments. — John Atkins
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