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Microsoft eyes debt to finance LinkedIn buy

By Natalie Harrison and Hillary Flynn
June 14, 2016 11:07 IST
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Microsoft CEO Satya Nadella

Moody's said that, while the merger could improve Microsoft's cloud-based service platforms and LinkedIn's ability to connect professionals, the jump in Microsoft's debt could be enough to drop ratings by a notch.

Software giant Microsoft said Monday it will primarily use debt to finance its $26.2billion acquisition of LinkedIn, a tie-up that could put the company's Triple A credit ratings at risk.

Moody's said it was putting Microsoft's Aaa rating on review for a downgrade, citing the increased leverage that will be needed to fund the purchase.

But S&P Global Ratings said it believed Microsoft was committed to its top-notch rating and affirmed the credit at AAA.

Johnson & Johnson is the only other credit it rates as AAA.

Other analysts pointed out that even a $20-billion debt raise was small in comparison to Microsoft's roughly $400-billion market cap, and that investors would be keen to buy the paper.

Microsoft saw its shares fall 2.6 per cent on Monday, while the company's bonds were between 6bp and 14bp wider, according to MarketAxess data.

President Brad Smith said on a call with investors that the company would raise the debt 'opportunistically during favorable market windows'.

Investors have been lapping up large investment-grade M&A deals this year, including a $46-billion offering from AB InBev and a $20-billion deal last month from computer giant Dell.

The company is also cash rich, although a significant portion of that cash is held offshore.

As of September 2015, only $3.3 billion of Microsoft's $99 billion of cash and liquid investments was maintained domestically, according to Moody's.

The company has used the US dollar bond market to finance its share buybacks, and reiterated on Monday its intention to complete the $40-billion programme by the end of the year.

Its most recent US dollar bond offering was a $13-billion seven-tranche jumbo issue in October 2015.

It paid coupons of 1.3% on a three-year bond and 4.75 per cent on a 40-year issue, offering a new issue concession of just 3bp-6bp across all of the tranches.

Bank of America Merrill Lynch, JP Morgan and Wells Fargo were active book runners on that deal.

Morgan Stanley was exclusive financial advisor to Microsoft on LinkedIn, though other banks are expected to be involved in the lineup for the debt financing.

"They have a big bank group, so you would expect it to bring in several of them," one debt capital markets banker told IFR.

"Everything will be up for discussion."

Moody's said that, while the merger could improve Microsoft's cloud-based service platforms and LinkedIn's ability to connect professionals, the jump in Microsoft's debt could be enough to drop ratings by a notch.

"Funding the acquisition entirely with debt, however, will increase Microsoft's gross debt-to-Ebitda to approximately 2.0 times, in excess of 1.5x leverage Moody's has previously noted could pressure the rating," Richard Lane of Moody's said in a statement.

CreditSights analysts said gross leverage would likely increase to 1.9x from 1.3x if the LinkedIn purchase is fully debt financed.

"We would expect gross leverage to rise above 2x over the next 1-2 years driven by this deal as well as shareholder returns," said CreditSights.

But even that risk is unlikely to significantly impact Microsoft's cost of capital, a syndicate banker said.

"We've had so much compression in the rating spectrum lately [with the rally in bonds]," the banker said.

"It's not like they're getting a ton of advantage as Triple A's any more."

Profit or loss for traders?

While Most LinkedIn shareholders a big reason to cheer, one trader who had just laid an intricate options bet looks to be smarting from a big loss.

On Friday, the largest trade in LinkedIn's options was an "iron condor," a complex strategy that involves buying and selling of call and put options simultaneously.

Buying a call conveys the right to purchase shares at a fixed price in the future, while buying puts conveys the right to sell shares. Selling calls and puts creates the opposite obligation.

The trade would have delivered its maximum return if LinkedIn shares effectively flatlined around Friday's level near $131 over the next two months.

But then LinkedIn shares shot up 47 per cent after the Microsoft news, torpedoing the trade and leaving the trader with an estimated loss of nearly $1 million.

The trader, whose identity is not known, bought 500 LinkedIn calls betting on the shares rising above $185 by mid-August, and sold the same number of calls betting on the shares staying below $160 by that date.

At the same time, the trader also bought 600 puts that would profit if the shares dipped below $115, and sold the same number of puts that bet the shares would stay above $125.

All in, the trader pocketed roughly $275,000 for setting up the trade and would get to keep it all as long as the shares held between $125 and $160 through the August expiration of the options.

Instead, with Microsoft offering $196 a share and the stock jumping to north of $192, the position is well under water.

The trader stands to lose a little under $1 million, according to a Reuters calculation.

"A day after you sell it, there is a buyout -- I would call it the worst-case scenario," Henry Schwartz, president at options analytics firm Trade Alert said.

Reporting by Natalie Harrison and Hillary Flynn

Image: Microsoft chief executive Satya Nadella. Photograph: Reuters

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