LBO – Friend or Foe for Bondholders?
November 15, 2019
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.
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. Any opinions and statements contained herein of financial market trends based on market conditions constitute our judgment. This material may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different than that discussed here. The information presented, including any statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Although the assumptions underlying the forward-looking statements that may be contained herein are believed to be reasonable they can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. AAM assumes no duty to provide updates to any analysis contained herein. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.