IBM Bond Yields, Default Risk Spike After Red Hat Deal

While IBM’s stock is bouncing back modestly from an ugly open, bond market participants remain gravely concerned at what damage the Red Hat acquisition could do to IBM’s balance sheet.

As it takes on the second-largest technology deal of all time, IBM will likely incur at least $20 billion in additional debt, and as a result IBM’s already shaky A+/A1 rating could soon be downgraded to BBB.

For now the stock seems to be shrugging it off…

But the bond market most definitely is not…

As Bloomberg notes, IBM wants to eschew the route taken by many companies which sacrificed strong credit ratings to pursue large scale mergers and acquisitions that left them with lower, triple B rankings, according to S&P analyst David Tsui.

“The ratings are very important to them — their competitors in IT services are all rated A or higher,” Tsui said. Debt issuance will be “substantial” but with more than $6 billion in projected free cash flow, the company won’t have to go as close to funding the whole deal with debt, according to Tsui.

Short-dated bond yields have burst above 4%…

And more notably with regard the investment-grade credit rating, IBM bond risk is now dramatically higher than its peers in the IG Technology sector…

A spokesman for IBM pointed to the firm’s strong free cash flow and that the deal is accretive from the first year. He acknowledged the ratings agency moves adding that IBM remains in “solid investment grade territory.”

Bloomberg Intelligence analysts said in a report Monday that IBM may issue at least $20 billion of debt to fund the acquisition:

“The purchase of Red Hat for an enterprise value of about $34 billion, brings credit default swap and bondholder fears to fruition,” the BI analysts said.

“We have consistently highlighted enhanced event risk as IBM’s revenue growth remains stymied and its stock continues to fall.”

And that seems to be sparking a surge in demand for credit protection against IBM…

Moody’s placed IBM’s A1 rating on review for downgrade, projecting that gross debt to Ebitda, or earnings before interest, tax, depreciation and amortization, will exceed three times upon the transaction closing in the second half of next year.

Higher credit risk or not, IBM needed to do something, as we noted, revenues have continued the shrink and after a brief rebound, sales dipped once again this quarter, after an unprecedented period of 22 consecutive declines starting in 2012, when Rometty took over as CEO.

The post IBM Bond Yields, Default Risk Spike After Red Hat Deal appeared first on