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High debt costs drive equity and cash financing for M&A

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Union Pacific's ( UNP ) $85-billion deal may set sector record

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Investment-grade firms wary of debt to avoid downgrades

By Matt Tracy

Aug 5 (Reuters) - Top-rated U.S. companies have financed

their acquisitions mostly with equity and cash instead of debt

this year, and could continue doing so even as M&A activity and

hopes of interest rate cuts rise, bankers and investors said.

High debt costs and worries of credit-rating downgrades for

taking on debt made funding acquisitions with cash and stock

with sky-high valuations more compelling, they said.

Last week, rail operator Union Pacific ( UNP ) announced an

$85-billion deal to acquire Norfolk Southern ( NSC ), and

analysts expect it to finance the deal mostly with stock, some

cash, and $15 billion to $20 billion of debt.

The deal could set a record for the largest buyout in the

sector.

Such cash-and-stock deals have become popular due to a

narrowing gap between the pre-tax costs of equity and debt,

according to Piers Ronan, co-head of debt capital markets at

Atlanta-based investment bank Truist Securities.

Some $250 billion, or 11% of total M&A funding this year,

was stock funding, while 15.3% of deal volume was funded by a

mix of cash and stock, according to LSEG data.

This compares with $441 billion, or 14% of all M&A funding

in 2024 that was stock-funded and 7% cash-and-stock funded, the

data showed.

"Debt is not really so attractive right now -- because

equity is so attractive," Ronan said, pointing to its attractive

earnings yield.

Many corporations have posted strong earnings and generate

healthy free cash flow, which has contributed to "an uptick in

equity financing of M&A transactions and a little less reliance

on debt financing," said Natalie Trevithick, head of investment

grade strategy at Los Angeles-based asset manager Payden &

Rygel.

Investment-grade companies have also grown wary of adding

debt to avoid downgrades, which could increase their funding

costs.

Ratings agencies Moody's, S&P, and Fitch warned their

ratings on Union Pacific ( UNP ) could be downgraded if the company

pushes its leverage higher due to its planned Norfolk Southern ( NSC )

acquisition.

"(A ratings downgrade) is going to have a pretty big impact

on how your bonds trade in the secondary market," said Mike

Sanders, head of fixed income at Madison, Wisconsin-based asset

manager Madison Investments.

Sanders pointed to the poor trading performance of media company

Warner Bros Discovery's ( WBD ) bonds following its announced

split into two separate publicly-traded companies and downgrade

to junk status in June.

Less reliance on debt by M&A-intent companies could cause

end-of-year volumes for investment-grade issuance to fall short

of their $1.5-trillion level in 2024, bankers said.

The average spread on investment-grade bonds was last at 82

basis points, just shy of the 77-bps level it touched in 1998,

according to the ICE BofA U.S. Corporate Index.

Kyle Stegemeyer, head of investment-grade debt capital

markets and syndicate at Minneapolis-based U.S. Bank, expects

M&A-related bond supply to total $225 billion in 2025.

"As we move deeper into the year, it becomes less likely

that we get the large multinational transformational M&A

financed this year to help drive the numbers materially higher,"

Stegemeyer said.