LBO rumours cause heightened CDS prices

Some of the recent increases in CDS activity that CreditLime has previously identified, such as in the case of Lubrizol, is being collectively attributed to speculation about the possibility of some companies being taken over in leveraged buyouts (LBOs).

A Bank of America report from last Friday mentioned the possibility of five companies that could be buyout candidates and recommended buying protection (buying CDS) on them. The companies are Lexmark, Pactiv, Lubrizol, Harris and U.S. Cellular – all which have seen increases in their CDS prices. Barclays also reported that Computer Sciences might be another target.

The reason LBO speculation can send CDS prices higher is because those types of buyouts involve issuing new debt, often borrowed at the individual company level, to finance the purchase and privatization of the target. The company then ends up with more debt – and higher interest costs – after the transaction which theoretically increases the credit risk of the bought-out company. In the past, some LBO’s have utilized an unmanageable amount of debt (i.e. too much debt) that ultimately ended up landing the company in bankruptcy (such as the case of Chicago Cubs baseball team and LA Times newspaper owner Tribune)  because those companies could no longer meet the higher interest costs associated with their over-leverage.