Corporate Credit Research

August 10, 2018 11:30 AM GMT

Corporate Credit Research

M&Aking a Leveraged Balance

Sheet

We walk through how M&A has shaped the IG market in this

cycle, looking at both fundamental trends and technicals in

markets, and think about risks going forward, particularly

important at this late stage in the cycle.

M&A bythe numbers: After a slowdown in activity in 2016/17, the pace of M&A

jumped in 1H18,hitting a record absolute level (+70% y/y), though it remains

more muted when normalized by market cap. Year to date, IG issuers have

brought $168 billion in acquisition-related financings to market and, based on our

estimates, M&A issuance in 2018 will likely reach an outright record. Even on a

percentage basis, M&A issuance is still significant, currently representing about

25% of total supply.

Thefundamental impact: M&A has contributed to near-record-high IG leverage

levels today and the deterioration in ratings quality of the IG index this cycle.For

example, BBB bonds in the IG indexused to fund M&A have grown from $93

billion in 2009 to $462 billion today (+395%), compared to overall non-fin BBB

indexgrowth of “just” 170%. Additionally,updating our leverage-implied ratings

analysis, we find that ~45% of IG non-fins, by par, would have a HY rating, if

rated based only on leverage,up from 30% in 1Q17 and 8% in 2011. Issuers who

have funded M&A with debt account for two-thirds of the “implied HY” bucket.

Late-cycle M&A is riskier: Issuers have been able to justify this leverage in part

because of pledges to quickly de-lever. In reality, while leverage does drift lower

in the years after a transaction (after jumping meaningfully at deal completion),

issuers have consistently missed initial deleveraging targets. And remember,

companies have fallen short of goals at a time when the economy has been

consistently growing and monetary policy has been very easy. Going forward, it

will only getharder. Starting leverage levels are higher, monetary policy is

tighter,and the likelihood of a recession at some point in the next few years

grows as we get later and later in this cycle.

Thetechnical impact: Particularly at the extremes, M&A volumes can clearly

impact aggregate market performance. Additionally, we find that the ability of

the market to digest large deals has declined modestly this year as overall flows

have weakened. Going forward, the macro backdrop still seems conducive to

further late-cycle M&A and, based just on already-announced transactions, we

conservatively estimate $100 billion of M&A-related issuance still to come in

2H18 and into the beginning of 2019, with upside risks to thatnumber.

Felician.Stratmann@morganstanley.com

Adam.Richmond@morganstanley.com

Vishwas.Patkar@morganstanley.com

Frederick.Fuchs@morganstanley.com

MORGAN STANLEY & CO. LLC

Felician G Stratmann

STRATEGIST

+1 212 761-1353

Adam S Richmond

STRATEGIST

+1 212 761-1485

Vishwas Patkar

STRATEGIST

+1 212 761-8041

Frederick T Fuchs

STRATEGIST

+1 212 761-4839

Exhibit 1: ~45% of US IG non-fins have leverage

consistent with a HY rating, up from ~30% in 1Q17 and

8% in 2011, skewed by M&A deals

4% 0%

6% 3%

36%

19%

54%

34% 30%

15%

0.1% 0%

13%

26%

39%

52%

65%

Implied

Aaa Aa A Baa Ba B Caa

Implied Ratings by Leverage (by Par Amount)

No M&A Issuance (since '13) Issued Bonds to Fund M&A (since '13)

Source: Morgan Stanley Research, Moody’s, S&P LCD.

Note: As of most recent financials available since YE2017

Exhibit 2: An increasing proportion of BBB-rated debt

can be linked to M&A

676

1,824

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

Jan-09 Jul-18

($bn) Non-Financial BBB-Rated Index Debt

M&A-Related, BBB-Rated Other BBB

+170%

+395%

Source: Morgan Stanley Research, FTSE Fixed Income LLC, Bloomberg

Note: M&A-related category onlyreflects bonds that have publically disclosed

use of proceeds

Dueto thenature of thefixed incomemarket, theissuers or

bonds of theissuersrecommended or discussed inthis

report maynot becontinuously followed. Accordingly,

investors must regard thisreportas providing stand-alone

analysisand should notexpectcontinuing analysis or

additional reportsrelating to suchissuers or bonds of the

issuers.

Morgan Stanley doesand seeksto do business with

companiescovered in Morgan Stanley Research. Asa

result, investorsshould beawarethat thefirm mayhavea

conflict of interest thatcould affect the objectivity of

Morgan Stanley Research. Investorsshould consider

Morgan Stanley Researchas onlya singlefactor in making

their investment decision.

Foranalystcertification and other important disclosures,

refer to the Disclosure Section, located at the end of this

report.Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Actual

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Introduction

Recent M&A Trends

The pace of M&A activity in 1H18 was significant,up 70% versus the same period last

year. These transactions have had a noticeable impact on the investment grade market,

influencing both supply/demand dynamics and fundamental trends within the asset

class.

In short, looking at technicals, we show that a higher portion of M&A-related issuance in

a month,not surprisingly, tends to have a negative effect on spreads overall,and that

the trend of spreads tightening on M&A deals in the months after issuance has started

to weaken. More importantly, focusing on fundamentals, we find that M&A activity has

contributed meaningfully to aggregate IG leverage, which now sits near record highs.

Thinking more about IG balance sheets, we point out that although acquirers in many

cases have been able to appease the market in the short term by pledging fast

deleveraging, forward-looking assumptions often assume all goes well and earnings

growth is strong. In reality, issuers have been slow to actually delever,and as we

progress later and later into this cycle, the ability to do so may become even more

challenging.

In fact, the key risk is that a downturn hits at some point in the next few years, with prerecession IG leverage higher than ever before. Not only do companies struggle to

delever in that scenario, but leverage jumps further as earnings decline, which is

typically how it works when the cycle turns. Hence, some of these IG capital structures,

which made sense only based on optimistic delevering assumptions, start to look too

highly rated,and even like high yield credits in the extreme cases. And remember, the

market will move before the economic data turns,and well before any meaningful wave

of either defaults or downgrades.

In the report that follows, we walk through how M&A has shaped the IG market in this

cycle, looking at both fundamental trends and technicals in markets,and think about

risks going forward, particularly important at this late stage in the cycle.

In absolute terms, M&A volumes hit a record pace in the firsthalf of 2018, with nearly a

trillion dollars in US deals announced. Activity peaked at similar absolute levels near the

ends of prior cycles, in 1998-2000 and again in 2007 (Exhibit 3).

Of course,normalized by market cap, M&A has looked more muted in this cycle (Exhibit

4). By this metric, trailing 12M M&A is running at about 7% of the S&P 500 market cap

and peaked at around 10% in 2016, compared to prior cycle peaks of 13% in 2007 and

20% in 1998.

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Exhibit 3: In absolute terms, M&A set a record in 1H18... Exhibit 4: ...relative to market cap, M&A levels have been more muted

in this cycle

($bn) Announced US M&A - First Half Volumes

1,000 US Announced M&A, Relative to Market Cap 25% 900

800 20%

700

600 15%

500 10% 400

300 5%

200

100 0%

88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

0 US Recession T12M M&A % of S&P500 Market Cap Long-Run Avg. 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

Source: Morgan Stanley Research, Thomson Financial, Datastream, Bloomberg, NBER Source: Morgan Stanley Research, Thomson Financial

However, when thinking about the impact on corporate fundamentals in a cycle, we

believe cumulative M&A volumes (not just volumes in a single calendar year) are also

important to consider. And in part given the length of this cycle, cumulative M&A

volumes have been substantial, with over $11 trillion in deals announced since 2009,

compared to $5.8 trillion between 2001 and 2007,and $7.7 trillion between 1991 and

2001.

More qualitatively, the driver of M&A is often a bit different from one cycle to the next.

This time around, weak organic growth over the course of a long subpar post-crisis

recovery, combined with a very cheap cost of debt for many years, stoked M&A early on,

as companies looked to acquisitions to boost earnings. The pace of deal activity did slow

in 2016 on the back of the Energy bust,and M&A fell further in 2017 as uncertainties

about tax reform, regulatory scrutiny,and public policy weighed on sentiment. In 2018,

we have seen a resurgence of M&A, this time driven by stronger global growth as well

as rising animal spirits on the back of tax reform, on top of increased confidence about

the regulatory environment followingheadline-deal approvals (i.e., AT&T/TimeWarner).

Exhibit 5: $11 trillion in US M&A over the course of this cycle

($bn) US Announced M&A - Monthly

86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

Monthly Volume US Recession 12M Moving Avg. Volume

Source: Morgan Stanley Research, Thomson Financial, NBER

Robust M&A activity has clearly impacted debt markets, contributing to substantial

investment grade issuance for years. Year to date, IG issuers have brought $168 billion in

acquisition-related financings to market, putting the total for the cycle around $1.5

trillion since 2009. Additionally, our estimate of the IG M&A-related deal pipeline

0

50

100

150

200

250

300

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through the end of the year (more in the last section below) shows that M&A issuance

in 2018 will likely exceed 2017’s pace by over 25% and could reach an outright record

(Exhibit 6). Even when normalized for the overall level of issuance, M&A-related

financings are still significant, currently representing about 25% of gross and 51% of net

supply so far this year (Exhibit 7).

Exhibit 6: Total IG M&A-related supply could reach record levels in Exhibit 7: As a % of total gross or net supply, M&A issuance looks even

2018 more substantial

60%

50%

40%

30%

20%

10%

0%

IG M&A as % of Issuance

96 98 00 02 04 06 08 10 12 14 16 18YTD

% of Gross Issuance % of Net Issuance

Source: Morgan Stanley Research, S&P LCD, Bloomberg Source: Morgan Stanley Research, S&P LCD, Dealogic, Bloomberg

Impact on Fundamentals

Leverage for our investment grade universe has been at or near record highs for the

past few quarters and has increased dramatically over the course of this cycle. As we

have discussed many times in the past, current leverage levels are particularly

concerning,given leverage generally peaks in or after a recession, which means when the

economy does turn, it is likely going even higher (Exhibit 8). The buildup in IG leverage

over the course of this cycle has coincided with slow growth and extremely

accommodative central bank policy,encouraging substantial debt capital structures.

These same factors also made ithighly attractive for corporates to fund M&A with debt,

which has clearly contributed to the buildup in IG leverage.For example, simply

excluding any issuers in our database thathave funded M&A with debt (since 2013)

shows median gross leverage at lower levels,especially in recent quarters (Exhibit 9).

Exhibit 8: IG leverage is near all-time highs, despite the fact that the Exhibit 9: Excluding issuers who have financed M&A with debt,

economy is still healthy; leverage typically rises most in recessions leverage has still risen but looks better

(x) Investment Grade Gross Leverage (x) Investment Grade Gross Leverage ex-M&A

92 94 96 98 00 02 04 06 08 10 12 14 16 18 13 14 15 16 17 18

1.00

1.20

1.40

1.60

1.80

2.00

2.20

2.40

2.60

1.75

2.00

2.25

2.50

2.75

US Recession Gross Leverage Gross Leverage Gross Leverage (ex-M&A Issuers since 2013)

Source: Morgan Stanley Research, Bloomberg Source: Morgan Stanley Research, Bloomberg, S&P LCD

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To examine these dynamics a bit further, we repeated and refined our leverage-implied

ratings analysis first detailed in Corporate Credit Research:Living the HY-Life

(2017.07.28). Here, we calculate the “implied” rating for each non-financial US-based IG

issuer assuming leverage as the sole criteria for a rating. In other words, we compare

each IG issuer’s current leverage level against the thresholds that define Moody’s rating

categories for leverage (unique to each sector). Compared to the last time we ran this

analysis in 1Q17 – which showed ~30% of IG par value at HY-like leverage levels – now

~45% of this universe, by par,has leverage consistent with a high yield rating (Exhibit 10).

This meaningful increase has been driven mainly by large issuers whose leverage (as

defined and adjusted by Moody’s) is now consistent with a HY rating (again, ignoring

other factors that go into a rating), such as AT&T, CVS Health, Pepsi, Qualcomm,

Northrop Grumman,Lockheed Martin,and Kroger (representing over $220 billion in

index debt), to name a few.For comparison,a simplified version of this analysis shows

that just 8% of the universe had an implied HY rating much earlier in this cycle in 2011.

If we break out the issuers who have funded M&A with new debt over the last five

years, we see that they account for around two-thirds of issuers that fall in the “implied

HY” bucket, showing the propensity for M&A transactions to add significant credit risk.

Exhibit 10: ~45% of US IG non-fins have leverage consistent with a HY rating, up from ~30% in

1Q17 and 8% in 2011, skewed by M&A deals

65% Implied Ratings by Leverage (by Par Amount)

54%

4% 0%

6% 3%

36%

19%

34%

30%

15%

0.1%

0%

13%

26%

39%

52%

Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Actual

Implied

Aaa Aa A Baa Ba B Caa

No M&A Issuance (since '13) Issued Bonds to Fund M&A (since '13)

Source: Morgan Stanley Research, Moody’s, S&P LCD

Note As of most recent financials available since YE2017

Issuers have been able to justify this incremental leverage for various reasons, such as

scale of business, low rates,and most importantly, because acquirers have pledged to

delever quickly or at least maintain an IG rating. Of course, the key questions: Have

issuers actually delevered over time,and how realistic are these pledges to cut leverage

going forward?

On the first point, we have observed that leverage increases at the completion of an

acquisition and does generally decline over time. However, more importantly, most

companies thatundergo M&A ultimately do not get back to "pre-deal" leverage levels

(Exhibit 11).For example, in a cross-section of over 100 M&A transactions of announced

value $5bn+, where the acquirer was initially IG-rated, we observed a median leverage

increase of ~2x from announcement to completion (from ~2x to ~4x). Additionally,even

after 5 years, the median leverage level for this cohort was still over ~2.50x – a full half

turn of incremental leverage (which is notable for a large universe of IG companies).

5 
Exhibit 11: Even after 5 years, median leverage of IG acquirers is higher than pre-acquisition

(x) Median Gross Leverage at Acquirer (IG, $5bn+)

4.50

4.00

1.00

1.50

2.00

2.50

3.00

3.50

Source: Morgan Stanley Research, Bloomberg

Note: Shows completed deals >=$5bn with IG rating at acquirer pre-acquisition

Now, leverage for our broader universe has generally trended higher over time, which

does impact the aggregate numbers.For example, median leverage pre-announcement

for deals in 2017 was 2.72x, compared to 1.13x in 2011. However,even controlling for

transaction year, Exhibit 12shows that M&A is still translating to higher leverage. The

only difference is that leverage is jumping to even higher levels on completion currently

vs.earlier in this cycle, in part given higher starting leverage for companies today.

Exhibit 12: Leverage keeps creeping higher both pre- and post-M&A

(x) Median Gross Leverage at Acquirer (IG, $5bn+), 6.00 by Announce Year

1.00

2.00

3.00

4.00

5.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010 2011 2012 2013 2014 2015 2016 2017

Source: Morgan Stanley Research, Bloomberg

Note: Shows completed deals >=$5bn with IG rating at acquirer pre-acquisition

Clearly, in some cases, the increase in leverage of these transactions has already flown

through to ratings.Looking at over 700 deals (with announced value of at least $1

billion) since 2010, which started as IG,24% of acquirers on average were downgraded

by at least one notch at one agency over the 6 months prior to the deal to the 6 months

after completion (Exhibit 13). And showing the increased aggressiveness of transactions

in 2018 YTD,27% of deals this year have been downgraded, 73% of deals have

maintained a steady rating,and no transactions have been upgraded,vs.at least some

upgrades in all prior years.

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Exhibit 13: Not surprisingly, M&A tends to lead to more downgrades than upgrades, clearly the

case YTD

Source: Morgan Stanley Research, Bloomberg

Note: Shows completed deals with announced value >=$1bn with IG rating at acquirer pre-acquisition

Hence, while leverage does trend lower in the years after an M&A deal, on average it

does not get back to pre-transaction levels,and that is after rising substantially on deal

completion. Ultimately,expectations for quick deleveraging are often disappointed.For

example, we focused on just 10 of the largest debt-financed M&A transactions in the

last 5 years (based on the largest bond deals for completed transactions, with publicly

available company statements on leverage targets post-acquisition) and looked at the

leverage metrics these companies achieved vs. their prior commentary in earnings, calls,

and press releases. We found thatnearly all of the acquirers failed to reach their stated

leverage target or took longer to do so than the timeline posited at announcement of

the transaction. Indeed, deleveraging goals often assumed too-robust earnings trends

going forward. These issuers ended up facing a mix of unexpected headwinds, both on a

sector and macro level.

The key point to remember is that Exhibit 11, Exhibit 12,and Exhibit 13all show the

leverage trends of M&A transactions over the course of this cycle – a time when the

economy has been growing continuously and when monetary policy has been for the

most part very accommodative. Even with this macro backdrop, companies have fallen

short of deleveraging goals on average.

The ability to meet deleveraging targets will only getharder, in our view: Monetary

policy is getting tighter,and the likelihood of a recession at some point in the next few

years grows as we get later and later in this cycle. Combined with the fact that starting

leverage for M&A transactions is even higher today, we see current late-cycle M&A as

particularly risky with negative long-term implications for credit markets broadly.

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Technical Impact of M&A

Index Composition

The IG credit markethas grown significantly over the last 10 years and is now quite lowrated, with nearly 50% of the index BBB rated,a theme that we have discussed in detail

(see Corporate Credit Research:Living the HY-Life,2017.07.28). The non-financial

portion of this debt totals $3.5 trillion, of which $1.8 trillion (51%) is BBB.Looking at the

25 biggest BBB-rated capital structures alone, we note that their cumulative debt load

($685 billion) is about as large as 50% of the High Yield index. Of these, 17 have issued

at least $1 billion to fund M&A with debt over the last several years and, in several

cases, the M&A financing represents a majority of the issuer’s debt capital stack.

Exhibit 14: The largest 25 BBB issuers are over half as big as the full HY index, and in many cases

have issued debt to fund M&A

($bn) Largest Non-Financial BBB-Rated Debt Complexes in IG

90.0 (US & Yankee) 60%

0%

10%

20%

30%

40%

50%

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

M&A-Related Issuance Other % of HY Index (Cumul., RS)

Source: Morgan Stanley Research, FTSE Fixed Income LLC, Bloomberg, ICE Indices

We see the rise of BBB-rated debt reflected in new issuance as well, with the proportion

of BBB-rated M&A issuance increasing over the last several years (Exhibit 15).For

example,year to date, 76% of M&A issuance has been BBB rated, meaning thatnot only

has M&A depressed ratings post-completion, but an increasing portion of M&A and

accompanying financing is also coming from already lower-rated companies.

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Exhibit 15: A greater percentage of M&A is coming from BBB rated companies

M&A Issuance by Rating

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

06 07 08 09 10 11 12 13 14 15 16 17 18

YTD BBB A AA AAA

Source: Morgan Stanley Research, S&P LCD, Bloomberg

Note: Uses only Moody’s rating at issue prior to 2012 and average rating of Moody’s and S&P thereafter

Looking at the impact of M&A on the index over the course of this cycle, in Exhibit 16 we

compare today’s IG universe to that at the beginning of 2009.For non-financials overall,

the index today includes $707 billion of bonds with stated use-of-proceeds as

acquisition-financing, representing 20% of non-fin bonds in the index. At the beginning of

2009, such bonds totaled only $150 billion and represented just 11% of non-fins. Hence,

bonds outstanding in this index that were originally issued to fund M&A have increased

by 369% in this cycle while the total IG indexhas grown by “just” 140% over the same

time period.Looking at BBB-rated bonds specifically, M&A-related issues grew from $93

billion in 2009 to $462 billion today,a change of 395% compared to overall nonfinancial BBB growth of 170%.

Exhibit 16: An increasing proportion of BBB-rated debt can be linked to M&A

($bn) Non-Financial BBB-Rated Index Debt

2,000 1,824

676

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

+170%

+395%

Jan-09 Jul-18

M&A-Related, BBB-Rated Other BBB

Source: Morgan Stanley Research, FTSE Fixed Income LLC, Bloomberg

Note: M&A-related category onlyreflects bonds that have publically disclosed use of proceeds

Putting this all together, we see thatnot only has M&A contributed meaningfully to the

growth in the IG index, but ithas also shifted more of that debt to lower ratings and is

doing so at an increasing pace. Again, we see this as one of the drivers that could

contribute to elevated fallen angel activity when the broader credit cycle turns,a theme

we have discussed in detail in past research (see Corporate Credit Research:Living the

HY-Life,2017.07.28).

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Pricing

Jumbo M&A issuance has also impacted supply/demand dynamics in credit markets. To

be clear, we are in the camp that investors often put too much weight on supply

expectations in driving views on where credit spreads are headed. Clearly, supply is just

one factor that drives spreads and, in many cases, the relationship between issuance and

excess returns is quite weak.For example,2017 was a record supply year and IG spreads

steadily tightened nearly all year. In 2018, IG supply is down ~11% YTD,and spreads

have widened most of the year.

That said, supply does matter,and we find that M&A-related issuance can have an

impact,especially at the extremes.For example,as we show in Exhibit 17, in months

where the proportion of issuance attributable to M&A is high, spreads tend to widen.

Specifically, when M&A-related issuance represents over 30% of overall supply (more

than double the average proportion), spreads on the month widened by 7-11bp on

average.

Exhibit 17: Spreads widen in months with high M&A-related supply

(bp) Average Monthly Spread Move vs M&A Issuance (since

12.0 2012)

Avg. M&A Issuance 8.0 Proportion: 15%

4.0

0.0

-4.0

-8.0

M&A Issuance as a % of Total Issuance (Monthly)

Source: Morgan Stanley Research, FTSE Fixed Income LLC, S&P LCD, Dealogic

This spread performance is in part due to the sheer size of M&A-related transactions in

this cycle.For example, since 2012, there have been 30 M&A deals over $10 billion in

size,and 73 over $5 billion. These deals are generally well-telegraphed and spreads for

the issuers tend to widen in expectation of the new issuance, both on account of

transactions fundamentals (lower credit quality), but also in anticipation of the elevated

new issue concessions that issuers have to pay to entice demand. As a result, these M&A

deals have subsequently tended to perform well in the secondary markets.

Focusing on deals since 2012, bonds issued in M&A financings generally outperformed

the index by 7bp in the first month after issuance (Exhibit 18). However, we note that

more recently, these deals have tended to outperform by a smaller margin and in 2018

to date, M&A-related deals have actually underperformed the market in the three

months after issuance. Granted, overall performance is still not poor, but the market’s

reward for digesting these financings seems to be declining. This dynamic could be due in

part to the more aggressive nature of recent deals,and in part due simply to a much

weaker flow environment in credit markets so far this year.

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We see a similar dynamic in the equity performance of acquirers as well. As our

ß Outperforming Underperforming à

colleagues in equity research show in a recentnote (see Quantitative Equity Research:

US M&A Activity: Mixed Signals in the Second Quarter,2018.07.26),acquirer stocks

initially outperform the market, butunderperform in the three months after

announcement (Exhibit 19), particularly for deals in the past year.

Exhibit 18: Performance of M&A bond deals has deteriorated in recent Exhibit 19: ...mirroring equity performance for acquirer stocks

years...

US Acquirer Stocks: Median Relative Price Returns Post

(bp) M&A Bond Performance 1.0% Announcement vs Index

4.0 0.5% 0.5% 0.5% 0.4% 0.5% 0.2% 0.2% 0.1%

0.0%

2.0

0.0 -0.1%

(0.5%) -0.3% -2.0

(1.0%) -4.0

-6.0 (1.5%)

-8.0 (2.0%) -1.8%

T+0 3 Days 1 Week 1 Month 3 Months -10.0 Since 2009 3Q17-2Q18 T + 3D 5D 1M 3M

All (since 2012) Since 2017 Since 2018 Source: ClariFi, Factset, Morgan Stanley Research

Source: Morgan Stanley Research, FTSE Fixed Income LLC, S&P LCD

Note: Shows median of bond spread change less index spread change over the same time period

Looking Ahead

Assuming financial conditions do not tighten too aggressively, the economic backdrop

and current bullish readings across a wide array of business sentiment indicators point

to further late-cycle M&A activity. However, just based on already-announced

transactions and company statements, we estimate $100-150 billion of M&A-related

issuance still to come in the second half of 2018 and into the first part of 2019, with

upside risk of potentially over $200 billion still to come, dependent on the outcome of

key transactions. This issuance is difficult to time,as issuers generally have bridge loans

in place that they can opportunistically refinance into permanent capital before or after

an acquisition closes. However,even the low end of our estimate would put the total

for M&A-related issuance close to its record high of $284 billion reached in 2015, while

M&A-related volume would likely account for the highest proportion of overall supply

post-crisis. Exhibit 20 shows our estimate for the pipeline of IG bond deals based on

publicly available statements and bridge loans currently outstanding.

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Exhibit 20: M&A issuance pipeline over the next 6-12 months

Source: Companyfilings, Morgan Stanley Research

Note: Shows low and high estimates of new bonds to be issued to finance M&A over the next 6 - 12 months, assuming transactions close

Ultimately, whether or not the pace of deal-making continues, M&A already completed

in this cycle has contributed to the decline in ratings and fundamental credit quality in

the IG market and will likely impact the magnitude of the next credit cycle. Even in a

very supportive environment, made possible by healthy economic growth and

unprecedented easing by global central banks for nearly a decade, corporates have

struggled to hit deleveraging targets post-M&A transactions. Assuming added risks from

tighteningFed policy, the reasonable likelihood of a downturn at some point in the next

few years,and with even higher starting leverage levels, the fundamental and macro

headwinds going forward will only grow.

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Disclosure Section

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The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they

have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Frederick T

Fuchs; Vishwas Patkar; Adam S Richmond; Felician G Stratmann.

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(as of July 31, 2018)

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Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

COVERAGE UNIVERSE INVESTMENTBANKING CLIENTS (IBC) OTHER MATERIAL

INVESTMENTSERVICES

CLIENTS (MISC)

STOCK RATING COUNT % OF COUNT % OF % OF COUNT % OF

CATEGORY TOTAL TOTAL IBC RATING TOTAL

CATEGORY OTHER

MISC

Overweight/Buy 1164 37% 306 41% 26% 544 38%

Equal-weight/Hold 1347 43% 359 48% 27% 648 46%

Not-Rated/Hold 49 2% 4 1% 8% 7 0%

Underweight/Sell 546 18% 75 10% 14% 215 15%

TOTAL 3,106 744 1414

Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investment

banking compensation in the last 12 months. Due to rounding off of decimals, the percentages provided in the "% of total" column may not add up to exactly

100 percent.

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Analyst Stock Ratings

Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a

risk-adjusted basis, over the next 12-18 months.

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Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a

risk-adjusted basis, over the next 12-18 months.

Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views

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market benchmark, as indicated below.

In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market

benchmark, as indicated below.

Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market

benchmark, as indicated below.

Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index or MSCI sub-regional index or MSCI AC Asia Pacific ex Japan Index.

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