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Capital Markets

The Importance of Managing Rating Agencies in Big M&A Deals

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May 28, 2019

Lesson learned: Find out all you can about the internal dynamics of the agency and take nothing for granted. 

Bond3Financing a large M&A transaction puts corporate treasury teams squarely in the spotlight as they juggle innumerable moving parts. One of those parts is managing how agencies including Moody’s, S&P and Fitch rate securities issued to finance a deal. The agencies might not be treasury’s top priority, but as one treasury team learned last year, not grasping how they intend to analyze a transaction can result in a confusing rating outcome.

Ambiguity, confusion. A member of NeuGroup’s Assistant Treasurers’ Group of Thirty speaking at the spring meeting sponsored by Chatham Financial described a process he said resulted in “rating confusion” after one rating agency gave an “ambiguous” range at the launch of an acquisition. As a result, the company faced a risk that the pool of possible investors would shrink—over fears of a future downgrade—driving up yields. And the same agency wouldn’t definitively rate the deal until it closed, while two others rated the bonds when the issuance was announced. 

The member said the company asked the agency, “What are you going to learn between now and closing?” and “What are investors supposed to think?” But the agency did not finalize its ratings until months later when the deal closed. 

Another source of potential confusion for investors: Because of certain provisions in the bond issue, one of the agencies continues to rate both the acquirer and the target rather than just one, meaning the company has to pay for both.

Foregoing RAS and RES. One possible reason for the less-than-ideal experience: The company did not pay to engage the ratings assessment service (RAS) or rating evaluation service (RES) at the agencies, in part because the analysts seemed to understand the deal well and there were not multiple financing scenarios which can make such engagements beneficial. 

Moody’s says its service allows issuers to request that the agency “considers one or more hypothetical scenarios at a committee-level, and deliver a written response as to how a rating committee would likely rate those scenarios.” S&P’s website says its service “gives you a confidential assessment of the potential credit impact of your proposed strategic initiatives before you implement them, to identify the planned initiatives that potentially could lead to credit outcomes that you would view as more or less favorable.” 

Some AT30 members said the price for these engagements is normally a couple hundred thousand dollars. The member company indicated that if doing the financing again, RAS and RES would probably have been worth the cost.

Understand internal agency dynamics. Another possible factor: silos and internal politics within the agency that played out in the ratings process. Better communication with the analyst covering the acquirer and the one following the target company may have helped the agency come up with one view, especially since the targeted company’s analyst is senior to the analyst covering the acquirer, the member said. However, while the agency failed to communicate these dynamics, the member said his company should not have relied on the agency for insight into its inner workings. “It falls on us to go beyond what they say,” he said.

The good news. The member company’s imperfect interaction with the rating agency did not have a negative effect on the pricing of the bonds, an indication of the success of the approach taken by the company and its bankers to marketing the bonds. And for all the worry the agency caused the AT30 member, the treasury team learned some valuable lessons about understanding rating agencies’ internal dynamics while juggling due diligence, integration planning, bridge financing, loan syndication, a credit facility phased upsize, the bond structure/guarantee design, rate hedging, the bond proceeds investment strategy and the closing flow of funds. 

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