Safeway Inc. (SWY:US) bonds are signaling the grocer’s borrowing costs will rise about 33 percent to fund its $9 billion buyout by Cerberus Capital Management LP as the new owner piles on debt to merge the company with Albertsons.
Safeway’s 7.25 percent notes due in February 2031, which are unusual in that they will remain outstanding after the planned takeover, have lost 6.7 percent in the past month, the most among consumer staples companies. The 7.6 percent yield indicates the second-largest U.S. grocer would have to pay about 6.36 percent on new 10-year notes to entice investors to finance the deal. Safeway’s previous 10-year issue yielded 4.79 percent when it was sold.
Cerberus, which pulled down Albertsons’ ratings from investment grade to a single B with its 2006 buyout, is poised to do the same to Safeway, the 2031 bond yields indicate. The deal will lead to “significantly higher” leverage that could result in a multiple-level cut of Pleasanton, California-based Safeway’s Baa3 rating, according to a Moody’s Investors Service report last week.
“There will definitely be a significant deterioration in credit metrics if the deal goes through as proposed,” Mickey Chadha, a Moody’s analyst, said in a telephone interview. “The transaction will result in approximately doubling the debt load.”
The $600 million of 2031 notes and $150 million of 7.45 percent bonds due in September 2027 lack provisions that typically require securities to be repurchased at 101 cents on the dollar after a change of ownership. Its $250 million of notes due in August that also lack the change-of-control covenants will mature before the expected close of the deal.
Christiane Pelz, a spokeswoman for Safeway, declined to comment on the company’s new capital structure. Christine Wilcox, a spokeswoman for Albertsons, declined to divulge the company’s financing plans for the merger.
The yield on the company’s 2031 bonds is about equal to the 8 percent on single B rated securities in the Bloomberg USD High Yield Corporate Bond Index. Those bonds have an average maturity of about 17 years.
The average yield on B rated unsecured notes that will come due in about 10 years is 6.36 percent, Bloomberg data show.
Safeway’s 2031 bonds sold in 2001 were trading as high as 120.2 cents on the dollar in the last year to yield 5.46 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
There were “widely different outcomes for different sets of bondholders, and the market is reflecting this,” Carol Levenson, an analyst at bond researcher Gimme Credit LLC who grades the Safeway’s debt that will remain outstanding “underperform,” said in an e-mail. “The longer bonds will be hurt the worst.”
Only three of about 25 private-equity purchases of more than $1 billion announced in the last year involved bonds that lacked change-of-control covenants, according to data compiled by Bloomberg.
Albertsons has obtained $7.6 billion debt financing commitments from Bank of America Corp., Citigroup Inc. and Credit Suisse Group AG, according to a Safeway regulatory filing this week. Albertsons’s investors and their affiliates will kick in $1.25 billion in equity to fund the deal.
Safeway’s outstanding borrowings will be repaid at the completion of the transaction, which is expected to happen by the fourth quarter of this year, other than its notes maturing in 2019 and beyond, according to a March 6 company statement.
The debt repayment may total about $3 billion after taking into account the change-of-control provisions on Safeway’s 2019, 2020 and 2021 notes that are likely to be returned to the company, Fitch Ratings analyst Philip Zahn said in a March 7 report.
That may be funded by about $2 billion of the $2.9 billion of cash Safeway will have available when the transaction closes, Zahn wrote.
“There is still more downside risk” in the two categories of Safeway bonds that will remain outstanding after the takeover, Dave Sekera, a bond strategist at Morningstar Inc., said in a telephone interview.
Safeway, which went public in 1990 after KKR & Co. bought the company in 1986 for about $4.3 billion, said Feb. 19 that it was in talks about a potential sale as it divests some assets and tries to increase revenue.
The $40-a-share Cerberus offer to buy Safeway and its 1,335 U.S. stores would help the chain compete with grocers such as Kroger Co. and big-box retailer Wal-Mart Stores Inc.
The Albertsons-Safeway entity would create a company with more than 2,400 stores, 27 distribution facilities and 20 factories. Safeway has the highest market share in 12 of the 43 metro markets where it operates stores and it is second or third in an additional 20, according to Metro Market Studies data quoted by Bloomberg Industries. After the Safeway acquisition, Cerberus will have access to an additional 14 metro markets where Albertsons has little presence including Washington, San Francisco and Austin, according to a March 7 report from Bloomberg Industries’ analyst Jennifer Bartashus.
Cerberus teamed up with Supervalu Inc. and CVS Corp. in 2006 to acquire Albertsons in a deal valued at $17.4 billion. They then split up the company. Supervalu acquired more than 1,110 Albertsons stores, while Cerberus led a group that separately picked up 655 sites, mostly in Florida and the western U.S.
Last year, a Cerberus-led group bought Supervalu’s Albertsons, Acme, Jewel-Osco, Shaw’s and Star Market grocery stores in a deal valued at $3.3 billion. The group also paid $216.7 million for about a 21 percent stake in Supervalu.
“Cerberus is an experienced operator of grocery stores,” said Marc Gross, a New York-based money manager at RS Investments who oversees $4 billion in fixed-income funds. “They’re seen as pretty astute operators. They know the space.”
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