Using High Yield to Refinance Existing Debt

Issuers and sponsors can utilize the rising demand and liquidity in the High Yield space to refinance near-term loan maturities. Given rate volatility, new CLO creation has been muted for most of the year, creating a technical imbalance in demand. Approaching reinvestment deadlines for CLOs are limiting the ability for CLOs to roll their current investments into new deals.

Meanwhile, new senior secured bonds are proving to have more liquidity and demand. Senior secured bonds also allow for issuers to naturally hedge against rising interest rates. Today, the high yield market diversifies an issuer’s investor base and access to markets, offers fixed rate debt, and is pricing tighter than term loans. Recent secured bonds have priced ~150 bps lower in yield than term loans, and have tightened even further in the secondary market, trading ~184 bps tighter on average.

  • The most notable recent deal was the Hub International term loan and bond deal to refinance the company’s existing $6.4 billion of term loans, revolver draws, and to fund near-term M&A. While the term loan priced best-in-class for a B3 loan, the $2.175 billion secured bonds at 7.25% came 250bps lower in yield than the term loan that priced alongside it, reducing the company’s outstanding term loans by $1.7 billion.

Year-to-date, 18 refinancings or extensions collectively entail the repayment of $14.1 billion of institutional loans. At this point in 2022, there were only seven refinancings or extensions that collectively contributed to the repayment of $4 billion in institutional loans. The high yield market will soon emerge to be the most attractive way for issuers to reduce their institutional loan footprint. Inn 2022, there has been $12.1 billion of bond-for-loan takeout volume, accounting for 31% of all repayments unrelated to new issues. Comparable yields required for secured bonds are significantly lower than yields on pari term loans, in some cases 266 bps cheaper.

Acquiring a Stressed Company Trading Below Its Net Cash Balance As an Alternative Source of Financing

The 2020 and 2021 boom in SPAC fundraising – where the market saw a combined 861 SPAC IPOs, and the wave of De-SPAC transactions that followed – resulted in a meaningful number of companies with significant cash balances and little to no debt on their balance sheets. 

Those cash balances were intended to finance the growth and development of those businesses. However, economic headwinds in 2022 and 2023 raised questions about the viability of certain business models and led to depressed equity valuations across much of the De-SPAC universe. The Bloomberg De-SPAC index indicates a decline of approximately 80% over the last three years. Yet, many of those same firms still have meaningful cash balances and are trading (on a total market capitalization basis) at 60-90% below their net cash balances.

Public companies with financing needs could consider targeting one of these companies for acquisition as a potential alternative to more traditional financing structures. Through a stock-for-stock acquisition, the acquirer could use its equity currency to boost liquidity and potentially acquire attractive assets in a capital-efficient transaction.

(Sources: S&P and Statista data on SPAC IPOs for 2020/2021 & Bloomberg De-SPAC Index data for 2020 – 2023)

Upside for Rates Likely Capped as Economic Data Softens in the Fall

US Economist Tom Simons slightly raised his terminal rate forecast to 5.375% in the wake of the June FOMC meeting. There were a few key elements of Chairman Powell’s post-meeting comments that gave Tom the impression that one more rate hike is coming, but not two. First, Powell explained that the decision not to raise rates in June was part of a process of moderating the speed of rate hikes. Second, Powell, echoing many others, referenced the idea that moderating the pace of hikes while inflation remains unacceptably high is justified by the uncertainty surrounding policy lags. By the time of the late-July meeting, Tom does not believe there will be enough evidence of slowing growth and inflation to stop the Fed from hiking. Assuming a hike in July, he thinks the Fed will “skip” again in September, which means that the next opportunity to hike would be in October. However, by that point, Tom expects the data to have softened to the point that another rate hike will not be necessary. He anticipates significant declines in headline inflation, the rolling over of labor market data and increased pressure on consumption spurred by the likely September or October resumption of student loan payments.  

Chief Market Strategist David Zervos believes the major takeaway from the FOMC dot plot at the June meeting was that the current economic situation just isn’t that bad. The unemployment rate, which had been forecast to rise to 4.5% by year end, is now expected to be 4.1%. Headline PCE inflation is now projected to come down even faster, to 3.2%. Core inflation was the only negative update in the new projections, and is now seen ending the year at 3.9% instead of 3.6%, which is no doubt the primary reason why 50bps of additional hikes have now been put into the Fed’s SEP. Ultimately, Zervos believes that if core inflation gets back onto a path that looks set to hit 3.6% by year end, then the Fed skip will turn into a full-fledged pause. If, however, core inflation continues to be sticky and trend toward the new forecast of 3.9%, additional hikes are headed our way.

Global Head of Equity Strategy Christopher Wood highlighted several important trends. First, there is growing confidence that AI will provide the next productivity-enhancing growth narrative for the coming decade. He doesn’t believe that necessarily means the Big Tech stocks will be the dominant thematic for the duration, as he believes the picks and shovels theme remains the most compelling for now. Second, the fact that global investors still do not want to invest in Chinese stocks provides an explanation for interest in Japanese stocks. Third, the YTD weakness in oil has been due to a combination of concerns including Russia cheating the global sanctions regime, slowing demand in the West, the lack of a more vigorous recovery in China and further drawdowns of the US SPR. As a result, if OPEC supply remains constrained, the demand outlook is likely to remain the key variable for prices.

Generative AI — 10 Predictions Across All Sectors

Over the past several weeks, Jefferies’ US Research teams have been tasked with thinking about the myriad of ways that the rapid development and adoption of AI will forever change the industries they cover. In this piece we offer a compendium of their top 10 predictions on what the future of generative AI will mean for their individual universes. In addition, we offer the most compelling and consistent expected developments.

Bespoke…everything: Whether B2B or DTC, our analyst teams across a wide range of sectors (e.g., industrials, consumer, financials) expect that instant and personalized offerings will proliferate.

No really, everything: More accurate healthcare diagnostics, personalized drugs, a better understanding of genomes & disease risks, and perhaps even surgeonless surgeries.

The walls have eyes: Inventory management will be a cinch when cameras and weighted shelves eliminate checkouts, reduce shrink, and monitor out-of-stocks.

R&D time travel: Generative AI should accelerate the trend toward molecular modeling, virtual chemistry, searchable molecule libraries, and discovering novel ways to create chemicals and treat diseases.

What’s downtime? Everything from manufacturing to fleet management to ocean-going vessels to consumer autos will be maintained in real time, as AI should be able to predict what parts will be needed and when.

Armchair exploration: Both energy and mining companies will use AI to analyze subsurface/geologic data to better map and determine recoverable volumes and more complex ore bodies to meet growing global demand.

Unrisky business: Most notably for banks, lenders and insurance companies, underwriting, originations, and general risk management should all see substantial improvement. AI should even be able to detect fraud more quickly.

Weather or not: AI should finally be able to lead to better prediction of one of the trickiest and most everyday of issues. This could mean aircraft avoid the compounding effect of weather delays, and climate adaptation efforts dramatically improve.

Slicing through your inbox: Streamlining routine tasks like documentation, communication, verification and reporting should mean big, big, big productivity gains. And never having to lose half a Saturday to clearing to bring that pesky counter back down to single digits again.

BYOPaintbrush: If you thought we were good at imagining now, be warned that creativity is liable to explode. Whether creating multimedia content, designing buildings, coding complex algorithms, or even just planning a vacation, our personal, capable robot assistants will do more than just transfer knowledge — they’ll put every human on the shoulders of giants and redefine the phrase ‘if you can dream it’.

Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts. * Jefferies LLC / Jefferies Research Services, LLC † Jefferies International Limited

ECM New Issue Market Is Open

The second quarter of 2023 was the most active U.S. ECM new issue market since the fourth quarter of 2021.  We have seen increased primary equity issuance across all sectors and secondary share transactions from financial sponsors/insiders. 

While Q2 activity was been driven by public companies, the IPO market is continuing to show signs of its gradual re-opening. Jefferies was an active bookrunner on five IPOs in June.  U.S. IPOs included CAVA Group, Savers Value Village and Fidelis Insurance as well as PT Amman Mineral and Noile-Immune Biotech.

Former Airbnb CFO Laurence Tosi Preaches Caution and Patience

Preaching a gospel of caution and patience, Laurence Tosi, the founder and Managing Partner of WestCap Group, describes the last few years as an era when early-stage companies gained distorted valuations, built too fast on unproven business models, and rushed into IPOs before they were ready. 

As a result, Tosi said, young companies should work their way through the current economic climate by concentrating on the basics: be sure their runways are long enough to reach profitability, invest in activities that yield short-term returns, make efficiency a core competency, and continue to innovate.

Speaking at the Jefferies 2023 Private Internet Conference, Tosi advised that some companies can still keep an eye out for opportunities to make acquisitions, especially in situations where competitors are in turmoil.   

“A lot of our businesses are leaders in their space and their competitors are in distress,” Tosi said. “Now’s the time to be aggressive.” 

Tosi is a renowned entrepreneur and investor, who served as chief financial officer at Blackstone and Airbnb. Tosi founded WestCap Group in the late 1990s and returned to the firm full-time in 2018. WestCap’s focus is on investing in companies that are in a middle-stage of development.     

Amid a record downturn in venture capital activities and regional banking failures – when many mid to late-stage companies are scaling back their operations – Tosi said early stage companies have the opportunity to do well if they pursue a path of disciplined, sustainable growth.   

“Over the last few years, most of the disruption we saw was distortions in valuation. Companies tried to build too fast on models that were unproven,” Tosi said. “Seed-stage companies were receiving the valuations of established, late-stage incumbents.”

Tosi underscored the importance of companies having a solid business model before pursuing a public offering. By shoring up operations and allocating resources to high-performing business lines, companies can sustain investor confidence post-IPO.

“Market opportunity isn’t enough,” Tosi stressed. “Companies have to be ready – with the capital, branding, and culture to continue growing post-IPO. We always preach patience.”

As a first step, companies should scale back their operational cadence to ensure sustainability. Short-term return activities should be the priority, he said, while long-haul investments should be pursued with caution.

As for later-stage companies, Tosi said: “We’re advising companies to take their margins and invest them back in growth. Make efficiency a core competency and continue to innovate. Then, you can start to think about taking share in our tough market.”

Tosi stressed that one of the most critical issues facing a company contemplating an IPO is timing.

“We always believe the good companies will go out early [in the cycle] to price the IPO effectively so it will perform well,” Tosi said. “If you go back and you look at 75% of the IPOs or thereabouts in 2018 and 2019, techs were trading above their IPO price. It’s probably about 15% of the ones that went later in the cycle like 2022. And that’ll be a better experience for investors because if they want to sell they will be selling into a rising stock price and not a declining one.”

“Airbnb went early in the cycle,” he added. “They were right. They hadn’t even fully recovered from COVID, but they were right to go early because they had a great business model, leadership team and they were ready.”

Rather than wait for the best market opportunity, he said, wait until the company is ready and the IPO compliments the business model.

“Either you need the capital, the branding, or the ability to keep your employees with public stock,” he said. “Wait for those good fundamental reasons.”

How American Investors Can Learn from Chinese Innovation

Scan the vast landscape of China, its milling crowds of 1.4 billion people, its tens of thousands of competitive entrepreneurs, its vibrant start-up community, and you might just see something extraordinary: what American commerce will look like in the years to come.

So says Connie Chan, a general partner at Andreessen Horowitz, who has spent the last decade studying commerce in China in search of developing business trends and tell-tale signs of what may take hold in the American marketplace. She spoke about the predictive power of Chinese consumer technology trends for America and the world at the recent Jefferies Private Internet Conference.

“For the last ten years, I’ve had the strong belief that in consumer mobile internet, China is a place to learn,” Chan said. “When something takes off in China, it’s likely to take off all over the world.”

One reason for China being ahead of the United States in consumer technology trends is the sheer scale of competition and the number of companies that get funded in China. Comparing it to The Hunger Games, Chan said that in a competitive ecosystem in the United States there might be a handful of entrants, while in China there might be more than 20. The result is the generation of more successful ideas and businesses.

Another reason, at least in terms of e-commerce, is that in China smart phones were adopted as a primary way of buying and selling things long before the United States, she said. Even today, consumers in the United States are far less likely than the Chinese to make large purchases on their phones.

The result is that China is not only the largest market in the world, but a testing ground for other nations.

Chan recounted the early days of mobile internet when Chinese apps largely imitated their Western counterparts. This pattern flipped in 2011, with the launch of WeChat.

WeChat offered features beyond basic messaging, like mobile payments and social media, which were missing in Western alternatives. This marked a turning point for Chinese innovation, showcasing the country’s ability to spearhead groundbreaking technologies.

Intense competition soon emerged among Chinese entrepreneurs, fueling an innovation surge in Chinese consumer technology.

Micromobility – the use of lightweight vehicles such as bicycles or scooters for transportation – is a major trend that took off in China before making its way to the U.S. She pointed to Lime, an American micromobility start-up.

“By the time Lime reached American streets, two Chinese companies, Ofo and Mobike, had already secured Series B funding,” Chan said.

In studying Chinese business technology trends, Chan said she separated those business ideas that were China-specific – that is, would appeal largely to a local market – from those that ideas that addressed more universal problems that exist in other markets.

“Find things that have a clear product market fit and then try and figure out if there’s anything that’s culturally specific to that region or if it’s something applicable to all humans,” Chan said. “And if so, then go find the Western team that can leverage those learnings. Teach it to the Western team so they can grow faster with this kind of head start. And that’s worked out for us in quite a number of cases.”  

While artificial intelligence is expected to be the focal point of tech market growth, other sectors remain ripe for disruption. Chan emphasized e-commerce, where Asian platforms like Tmall and Taobao are leading a shift from search-based to discovery-driven shopping.  

“When you use Amazon, you’re probably going straight to the search bar. You’re not browsing Amazon for fun. But when we shop in real life, we’re usually browsing and window shopping,” Chan said. “Shopping has not been translated on the internet yet, but there are companies like Whatnot and Insider that are embracing this idea of product discovery.”

Why Hedge Funds and Banks Are Forging New Alliances

Shannon Murphy, Managing Director and Head of Strategic Content at Jefferies, discusses the importance of bank and hedge fund partnerships in successfully maneuvering current market volatility. During periods of transition, institutions that can lean on adept and responsive partners are better positioned to seize opportunities in the face of adversity.

In the wake of the pandemic, the last 18 to 24 months have ushered in significant changes, compelling both banks and hedge funds to prepare for an uncertain future. Transparent and candid communication between the two parties is essential to both establish the terms of their partnership and preempt potential challenges to come.

Banks and hedge funds can learn a great deal from one another as they aim to build new core competencies in uncharted waters. As new pressure points arise, it is important that they rely on each other and communicate openly about their needs. Collaboration will help both parties prepare for the unexpected.

Increasingly, volatility stems from developments across various sectors, including those in which one may not be directly involved. Unlike previous crises, which unfolded over weeks or months, we now see repercussions materialize overnight. It is more important than ever that institutions seek out adept and responsive partners, as opportunities to contain volatility may disappear in mere days.

Transparency and partnership are the two critical factors, intertwined and indispensable. Transparency, alone, is insufficient. It is critical to understand the multifaceted requirements of an organization and leverage a firm’s full range of expertise to address every need.

Hedge funds are not a homogenous group. The alternatives industry is incredibly varied and mature, with a continuing trend of innovation. While hedge funds invest in various asset classes, strategies, regions, and new products, they also need other key elements to thrive through volatility. These include treasury management, financing, asset raising, and pipeline management.

In a full-service bank, these key elements are readily available, and clients are likely aware of whom to contact with specific issues. Whether it’s a question about a new product, trading strategy, risk management query, or front-to-back support, clients have fast access to the right expertise. Establishing comprehensive relationships that cater to these diverse needs is critical – and particularly in the 2020s, which differ significantly from prior decades.

At present, the most efficient way for investment banks to collaborate with hedge fund partners is through a comprehensive, holistic approach. This involves exploring new strategies, products, and asset classes, as well as navigating periods of high and low deal flow. However, banks can add value across the entire industry by providing financial solutions and optimizing treasury management for hedge funds. By offering a full range of services, banks can substantially impact various aspects of hedge fund operations. This end-to-end servicing is vital in establishing and maintaining successful partnerships.

Our focus is on two key insights: first, forming partnerships that can withstand periods of volatility, and second, fostering new relationships that enable continuous mutual learning. The best method for avoiding stagnation and complacency is embracing new ideas. Whether it’s navigating the dot com bubble burst, the Global Financial Crisis in 2008, or dealing with the fastest-moving interest rate environment since the 1970s, progress is key to weathering turbulent times.

Today, many of our discussions either come from clients we haven’t heard from in some time, or from new clients seeking fresh insights. In this digital age, information is readily available at our fingertips – but data without context is meaningless. It fails to illustrate its significance to a specific investment process or risk management procedure. During periods of transition, it is crucial to collaborate with the right partners and obtain their insights. When crises are being measured in minutes and hours, you need to know the first phone call you make is the right one.