At the start of this decade the amount of listed equity in Europe weighted against total market capitalisation began to drop off.
The explanation for this was three-fold. Firstly, debt was cheaper than equity, so companies issued less stock. Secondly, European firms embarked on share buy backs to return funds to shareholders, meaning the amount of equity relative to total market capitalisation began to fall.
Thirdly, there was a gang of private equity investors stalking the public markets looking to take companies private, thus again reducing the total amount of equity listed on European exchanges.
“De-equitisation”, an ungainly term the FT’s John Authers wryly referred to at the time as Citigroup’s gift to the English language, was all the rage among European corporations during the giddy years.
This chart, compiled by the European equity strategy team at Bank of America-Merrill Lynch, shows this effect, as measured via Europe’s market capitalisation weighted against the level of the DJ Stoxx 600.
But, as you can see, this is no longer the case post-crisis. Equity is en vogue once again; and lots of it.
Dealogic say that $144bn of fresh equity has been issued by non-financial companies in Europe this year as debt is equitised and balance sheets are repaired. The market for European IPOs is again open for business after a near-two year holiday.
And, as the markets begin to realign after the acute phase of the credit crisis, debt has again become a cheaper form of funding than equity for several European sectors.
As this table shows, Healthcare, Media, Oil and Gas, Telecoms and Utilities all now have higher dividend yields than corporate bond yields.
Some of these sectors have specific technical factors impacting the price of their debt and equity – for example, the regulatory risk present in European utilities. But the trend in the wider market has been for the debt and equity yields to converge.
The iBoxx index of European corporate bond yields, excluding financials, is at 4 per cent, while the forward 2010 dividend yield on the DJ Stoxx 600 sits at 3.8 per cent.
So debt is in certain cases again cheaper than equity in Europe. But why should we care?
Though a counter-intuitive thought during what is meant to be a period of deleveraging, this could, logically speaking, prompt selective instances of resumed de-equitisation in certain sectors.
The argument is simple: when debt is cheaper than equity, companies who can will fund themselves using debt.
This will involve using debt to buy back their own shares, or to buy the shares of other companies (i.e mergers & acquisitions).
As Citigroup’s European strategy team recently noted:
Pressured by lower global GDP growth, CEOs will likely be forced to seek growth by any means. Attractive funding in debt markets may once again offer those companies with reasonable access the funding for growth through acquisition
Indeed, while the torrent of equity issuance this year has caught most of the headlines, debt capital markets are open to companies with strong enough balance sheets and credit ratings.
Excluding financials, over $549bn of corporate debt has been sold in Europe in 2009 thus far, according to Dealogic – the highest level since at least 1995.
But is this a post-crisis blip, or the beginning of a longer trend?
As the chart below shows, the gap between the 10 year bund, and the dividend yield on the Stoxx 600 has crossed over only twice in almost 30 years – during the turmoil of late 2001/early 2002 and 2008.
Markets are not currently signalling this situation will last. Stock markets appear primed for further gains, meaning the dividend yield will fall. Benchmark government bond yields are likely to rise due to higher national debt issuance, rising inflation expectations, and historically low returns weighed against other investments.
Related links:
The Short View: Why the US avoids de-equitisation
Land of the eternal ATM – FT Alphaville
“De-equitization” and its Discontents – NYT Dealbook