99 Cents Only Stores goes Lite

99 Cents Only Stores operates a chain of over 300 “extreme value retail stores” in California, Texas, Arizona and Nevada.The company was founded in 1982, and in January 2012 it was taken private by Los Angeles private equity firm Ares Management and the Canada Pension Plan Investment Board.  The new capital structure was typical of LBOs done at that time: Size (millions) % of Capitalization EBITDA Multiple(b) Revolver(a) $10 Term Loan $525 Total 1st lien debt $535 38% 3.4x Senior Notes $250 18% 1.6x Total Debt $785 55% 5.0x New Equity $536 Rollover Equity $100 Total Equity $636 45% 4.0x Total Capitalization $1,421 100% 9.0x (a) The Revolver commitment was $175 million, of which only $10 was borrowed at the time of the transaction (b) Using fiscal year 2012 pro-forma adjusted EBITDA, a reported by the company The company’s choice of loan products shows that one of its objectives was to maintain as much operating and financial flexibility as possible: The revolver is an Asset Based Lending (“ABL”) facility.  Compared to most secured “cash flow” revolvers, ABL facilities typically have fewer and less restrictive covenants.  In fact, it is common for ABL facilities to have no financial covenants, or to have financial covenants that are only measured if the company borrows most of what is available under the borrowing base.  This additional flexibility is a key advantage for ABL borrowers. The term facility is a Term Loan B (“TLB”).  This provides the company with significant cash flow flexibility.  It has amortization of only $5.25 million per year (i.e. 1% of the original principal) and a final maturity of 7...

The Refinancing Cliff Is Coming

The problems of the last leveraged buyout  bubble are still with us.  From 2004 through 2007, the U.S. experienced an unprecedented level of LBO activity.  That all ended with the collapse of the debt markets in the summer of 2007 (and the disappearance of the debt markets after the Lehman bankruptcy). LBOs are funded primarily with debt – somewhere between 60% and 80% of the capital structure.  These are the debt products used: Institutional Term Loans (also know as “Term Loan B” or “TLB”) – often the single biggest tranche of debt, these loans are sold to institutional investors, such as collateralized debt obligations (CDOs) and prime rate funds.  They have very little principal amortization and a final maturity of 6-7 years. Pro-rata Loans (comprised of a revolving credit facility and a Term Loan A) – these loans are sold to banks and typically make up a smaller part of the capital structure than the TLB.  Standard terms for a Term Loan A include significant principal amortization and a final maturity of 5 years. High Yield Bonds – are sold to institutional investors.  They have a bullet maturity (i.e. no principal amortization) and a final maturity longer than the Institutional Term Loans, typically 7-10 years. The Debt is Coming Due! Starting in 2012, we will see significant amounts of LBO debt coming due.  Knowing the typical maturities of the debt products and counting forward from the boom years of 2006 and 2007, first we’ll see large amounts of pro-rata loans come due, then institutional term loans, then high yield bonds, as this chart shows: What is the solution? Highly...

Primary and Secondary Markets for Corporate Debt

In earlier posts, we compared the pricing of corporate loans and corporate bonds.  Here, we’ll look at how these markets interact, both in primary issuance and secondary market trading.  First, some definitions:   The Primary Market is where financial instruments are sold from the issuer to investors.  This is often referred to at underwriting (in the bond and equity markets) or syndication (in the loan market).  As part of this process, securities often pass through an intermediary, such as an investment bank. The Secondary Market is where financial instruments are sold from investor to investor.  The issuer is not involved, and there is no underwriter (although there are brokers, and many underwriters also trade securities in the secondary market).   The Investors In the loan market, banks and institutions (such as collateralized debt obligations (CDOs) and prime rate funds) are the most active investors. In the bond market, institutions (such as mutual funds, pension funds, insurance companies and CDOs) are the most active investors; banks rarely buy corporate bonds. The key to rational pricing in these markets are the crossover investors – institutions, such as CDOs and certain other investment funds, that can buy loans and bonds in the primary and secondary markets.  By analyzing the relative value of loans and bonds, they decide which to buy.  For example, if the spread between loans and bonds is very large, investors may buy the bonds and shun the loans.  This increased demand for bonds will bring down their spreads in the secondary market, while the lack of demand for loans will increase their spreads in the secondary market.  Eventually, the...

Loan – Bond Relative Value

In our last post, we described how to compare the cost of a floating rate instrument, such as a loan, to the cost of a fixed rate instrument, such as a bond.  For one company, Jarden Corporation, we showed that the bond’s cost is 50 basis points higher than the loan’s cost.  Since both debt instruments were issued by the same borrower, shouldn’t they cost the same?   Corporate Finance 101 Whenever there is a difference in the cost or return of two financing instruments, corporate finance theory tells us to look to the risk differences between the two.  This applies if you are looking at it from the perspective of the issuer or the investor.  For this post, we will continue the Jarden example, comparing a loan and a bond for a non-investment grade issuer (note that the product terms, pricing, and risk characteristics for investment grade issuers are dramatically different).   Investor: Risk vs. Return As with Jarden, the yield on non-investment grade (i.e. “high yield”) bonds is typically higher than the yield on non-investment grade (i.e. “leveraged”) loans.  This is because high yield bonds are more risky to own than leveraged loans, for these reasons:   Priority: Loans to non-investment grade companies are typically senior and secured, while bonds to these same companies are typically subordinated and unsecured.  Thus, in a bankruptcy, the loans should get repaid before the bonds. Maturity and Amortization:  Corporate loans rarely come due beyond 6-7 years from issuance, whereas high yield bonds often mature in 10 years.  In addition, bonds typically have “bullet” maturities (i.e. all the principal comes due at...

Jarden Compares Loan and Bond Costs

Jarden Corporation (Ticker JAH) is a diversified consumer products company whose brands include First Alert, Holmes, Mr. Coffee, and Sunbeam.  On June 30, 2009, it had approximately $2.7 billion of debt outstanding, half of which was in the form of Term Loans due through 2012.  Management was eager to begin refinancing these term loans in order to gain additional covenant flexibility and extend maturities.  Over the next 7 months, it completed two transactions.   August 2009: “Amend and Extend”   In August 2009, the company extended the maturity of $600 million of Term B loans (“TLBs”) from January 2012 to January 2015 through the creation of a “Term B4” tranche.  This new tranche was priced at LIBOR + 3.25%.  The remaining $724 million of term loans remain due through 2012. Along with the TLB extension, the company extended the maturity of $100 million of its (unused) revolver from 2010 to 2012 and amended the covenants on its loan facilities to allow for additional securitization and other indebtedness. January 2010: Senior Subordinated Notes In January 2010, the company completed an offering of 7.5% Senior Subordinated Notes due 2020.  The offering consisted of two tranches: $275 million offered in the U.S. and EUR150 (approximately $217) offered in Europe. The company used a portion of the proceeds from this bond to repay a portion of its term loan, presumably those maturing through 2012. The U.S. tranche was priced at 99.139, for a yield of 7.625%, or a spread of 385 basis points over the 10-year treasury.   So which is cheaper? With LIBOR at 0.25%, the cost of the loan is 3.5%...