Through the LBO screen: Barcap suggests short play on corporates

Barclays Capital credit strategists suggest going short a basket of European corporates that are prime candidates for adding significant leverage, and hedging the position by going long the iTraxx main index excluding financials. In its latest European Credit Alpha report, the bank points out that private equity funds have significant capital available to invest in European LBOs. The analysts calculate that there is enough private equity firepower for about $150 billion of European LBOs even before any new funds are raised.

Barclays screened European credits for leveraging candidates, looking for low leveraged, cash-rich companies trading below 200 basis points, and further sifting using qualitative inputs. Among the top candidates for adding leverage are retailer Kingfisher, which has a CDS spread of 106bp but has said it is open to acquisitions, Finnish paper machinery maker Metso, which trades at 113bp in the CDS market, and Solvay. The chemicals company is sitting on €4.5 billion of cash from the sale of its drugs business to Abbott Laboratories, which partly accounts for its tight CDS spread of 73bp.

To reduce the risk of shorting single name leveraging candidates outright, the report suggests buying protection on a basket of eight names at an average of around 80bp at a ratio of 0.9, selling one times protection on iTraxx Main at around 102bp and buying 0.2 times protection on the senior financials basket of the main index at around 167bp.