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Major Corporate M&A Doubles Downgrade Frequency, Report

October 16, 2018, 08:09 AM
Filed Under: Mergers & Acquisitions

A quarter of companies making a major acquisition were downgraded, or placed on Rating Watch Negative or Negative Outlook immediately after the deal's announcement, based on our analysis of rating trends following 200 major transactions over five years, Fitch Ratings says. About 20% of companies in the sample were downgraded at least one notch in the year following an M&A announcement, which is roughly double the rate in Fitch's corporate portfolio as a whole. The proportion rose to 27% over two years.

Major acquisitions can fundamentally change an issuer's credit profile. This is because companies typically take on more debt to pay for the acquisition, thereby boosting leverage. Fitch takes a forward-looking, through-the-cycle approach to ratings and we only expect to take a rating action when a change to the credit profile is likely to be sustained.

This forward-looking approach to ratings means that subsequent near-term upgrades should be rare if an acquisition was the reason for our downgrade. This expectation is supported by the data, with only one company downgraded and then subsequently upgraded within two years of a major deal being announced. Similarly, the data shows that acquisitions rarely lead to a downgrade that is not signalled by a Negative Watch or Outlook at the time of the announcement.
Upgrades were significantly less frequent than downgrades overall, and when they occurred they were often non-investment grade companies whose ratings were constrained by their business profile, rather than by their leverage. Acquisitions paid for entirely with equity also resulted in more upgrades than downgrades in the sample, reflecting the fact that equity-only deals can strengthen business profiles, while any increase in the debt burden is limited to debt assumed from the target.

Larger deals are more likely to result in a rating action, but downgrades are still relatively frequent even when the target's EBITDA is less than 10% of the buyer's. Upgrades were most frequent where the target's EBITDA was at least 50% of the acquirer's. This is because of the transformational benefit that larger deals can have for the business profile of the acquirer, Fitch noted.

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