The LBO announcement for Tech Data was overshadowed by the rumor that Walgreens was interested in going private and approached by KKR. A $50B+ LBO of Walgreens would be the largest in history, far surpassing the $5B Tech Data transaction. We estimate a deal could require $35B of additional debt, bringing total lease adjusted debt to over $75B. Unlike Walgreens that has more than ten bond issues outstanding, Tech Data has two.
Bondholders have a “change of control” covenant to “protect” bondholders from LBOs, generally triggering an option to put the bonds to the company at $101 if credit ratings are downgraded to high yield once a company’s ownership structure changes. While this protection is “friendly” to bondholders, the problem arises when the bond price is greater than $101 before the announcement, which is often the case in low interest rate environments like we are in today. For instance, Tech Data’s 2027 bonds were trading with a price greater than $105 before the LBO rumor was floated, pushing the bond price down towards the change of control put price of $101. Similarly, Walgreens’ 2044 bonds were trading with a price greater than $106 before the news, now trading closer to par.
While these covenants are certainly helpful to bondholders and in some interest rate environments additive to performance, in the current low rate environment, LBOs are likely to be value destructive especially if bondholders lack the change of control protection. We would expect to see more LBO announcements, as the economics have improved with the low cost of funds and demand for yield across the world.