Debt Deluge at Anadarko

Updated from 2:25 p.m. EDT

The $24 billion financing package Anadarko Petroleum ( APC) scored for this morning's acquisition spree isn't for the faint of heart.

On Friday, the company unveiled plans to purchase Kerr-McGee ( KMG) and Western Gas Resources ( WGR) in two separate transactions that total $23.3 billion. Currently, Anadarko plans to pay for the acquisitions with a 364-day credit facility provided by its two advisers, UBS and Credit Suisse, and a third party, Citigroup.

Credit market sources say the loan probably will be short-term financing, requiring Anadarko, a $20.5 billion market-cap oil and gas driller based in Woodlands, Texas, to replace it during the next year with syndicated bank debt or bonds, or both. Such a structure isn't unusual for an investment grade company doing a deal of this size.

The company is going to do a number of things to finance the acquisition, a spokeswoman said. Divestitures, debt and equity issuance are possibilities. "But none of it has been decided yet," according to the spokeswoman.

Given the uncertain rate environment, could Anadarko find itself backed into a corner by waiting to refinance?

"The corporate bond market has been struggling lately," notes Edward Marrinan, head of credit strategy at JPMorgan Securities. "Valuations for all risky assets have backed up since the middle of May. The primary market has been offering price concessions to get deals done at the same time that secondary market participants have turned risk averse.

"In general, investors are not as willing to provide the pricing and structure on the terms that the issuers had become accustomed to during the last few years," Marrinan says.

Over the next few months, or course, bond markets could go either way. Although demand remains brisk for investment-grade debt like Anadarko's, it could waver depending on comments from the Federal Reserve meeting next week. If the Fed is dovish and economic indicators point to a soft landing, the bond market is likely to stay strong. But if the Fed continues to signal interest rate hikes, and debt becomes more expensive, Anadarko's $24 billion deal could become a costly one.

"It's hard for the market to strengthen, as there is this global reduction in liquidity caused by raising interest rates," says Gregory Peters, head of corporate credit strategy at Morgan Stanley. "Investors are reassessing the right risk premium. As global central banks to remove liquidity, investors wrestle with the impact."

Friday afternoon, Fitch put the company on negative watch, saying that the long-term ratings would likely be downgraded but that the company's debt would remain investment grade. Meanwhile, Moody's also placed the company under review for possible downgrade.

For now, Anadarko has promised it will quickly pay down the debt in 18 to 24 months by issuing equity or selling assets. According to the Fitch report, the company plans on paying down $15 billion of initial credit facility by issuing in equity and selling assets. The rest will be replaced with new debt. At those levels, the company should have no trouble covering interest with the $400 million of free cash the merged company would have produced in the first quarter. Certainly, investors hope Anadarko sticks to its promise for asset sales, given that the $24 billion credit facility is bigger than its stock market capitalization, and that the interest rate calculation gets more complicated as the rating changes.

But even that prong of its financing strategy could face trouble if equity markets continue to struggle. Just this week, private equity company Apollo pulled its initial public market offering of specialty chemicals company Hexion ( HXN), citing adverse market conditions. Other deals, such as Verigy ( VRGY), had trouble pricing and slumped in trading after the IPO.

So potential bond buyers won't find much security in Anadarko's promises to issue equity.

"Until the financing package has been finalized, bondholders are understandably skeptical about companies' promises to fund their acquisitions with equity," Marrinan says. "Thus, in assessing the risk of an M&A event, bondholders usually assume less equity will be used rather than more."

The banks lending to Anadarko might find themselves hamstrung as well. If bond market conditions worsen, and Anadarko drags its feet on issuing debt, the three lenders have tied up $24 billion in one company. Again, a heavy does of Fed hawkishness after next week's meeting in Washington is probably the most serious hazard here.

Still, for now, the banks are willing to take the risk.

"Attractive-yielding assets are in relatively short supply," says Marrinan. "Banks are in the market themselves, looking for higher-yielding assets to put their excess capital to work."

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