Sara Lee spinoff shift rattles bond traders
Sara Lee Corp.'s change of heart over which division to spin off is shaking the confidence of debt investors.
Credit-default swaps tied to the bonds of the maker of Jimmy Dean breakfast foods and Douwe Egberts coffee have jumped to the highest since Feb. 23 and prices of its debt fell after the company said June 14 it will spin off its beverage business, reversing an earlier plan to divest its meat operations.
The switch means lenders will be left with debt in a company that dropped its fastest-growing division. Downers Grove-based Sara Lee decided to split itself up after rebuffing leveraged-buyout advances in January. Sara Lee has $2.2 billion of long-term debt, including a $300 million euro ($425.1 million) bond that matures in March, according to data compiled by Bloomberg.
“There's really been a reversal,” said Dave Novosel, a Chicago-based analyst at debt research firm Gimme Credit LLC. “The coffee and tea business is showing greater revenue growth and its margins are generally higher; in that regard you'd say that might be the better business,” he said in a telephone interview.
Mike Cummins, a spokesman for Sara Lee, declined to comment.
Bond Prices
Sara Lee's $500 million of 6.125 percent notes due November 2032 have declined 2.1 cents to 95.448 cents on the dollar this week, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. At that price they yield 6.52 percent, or 234 basis points more than comparable- maturity Treasuries, up from 217 last week.
“The company has created volatility for bondholders,” said Joel Levington, managing director of corporate credit at Brookfield Investment Management Inc. in New York.
The cost to protect Sara Lee's debt from default climbed 27.6 basis points after the company announced its strategy shift to 149.6, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
The credit-swap prices imply Sara Lee debt is rated Baa3, the lowest step of investment grade, according to Moody's Corp.'s capital markets research group. Moody's Investors Service grades the company's debt Baa1, two levels higher, Bloomberg data show.
Investment-Grade Ratings
Management is targeting investment-grade ratings for both companies, according to a June 14 investor presentation in Paris.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The two separated businesses will aim for debt levels of no more than two times earnings before interest, taxes, depreciation and amortization, “consistent with a strong investment-grade company,” according to Brian Weddington, a New York-based analyst at Moody's.
Sara Lee's Ebitda was $1.2 billion in the latest four quarters, Bloomberg data show.
“This transaction is more than a spin-off of one business segment - we are really separating a global company into two, independent pure-play companies, which adds complexity as well as opportunity,” Executive Chairman Jan Bennink said in a June 14 statement. “There are greater efficiencies to be gained from spinning off the international coffee business.”
“We see important opportunities for growth coming from within our coffee and tea business,” he said.
Profit Margins
Pretax operating margins in the beverages business were 14.8 percent according to the company's quarterly filing for the period ended April 2, down from 21.7 percent in the year ago quarter. That compares with 12.5 percent for North American retail operations, which includes the meat and bakery units.
The meat business's full-year sales are projected to increase by 3 percent this year, while coffee sales are forecast to climb 9 percent, the company said in the investor presentation.
The beverage business accounted for 41.5 percent of revenue in the most recent quarter, according to the company's most recent filing. Meat made up 30.6 percent, the filings show.
Bakery Sale
Grupo Bimbo SAB, the world's largest bread maker, agreed in November to acquire Sara Lee's North American bakeries for $959 million. Bimbo is working with the U.S. Department of Justice “to agree upon potential remedies,” Sara Lee said in the statement. The company said the transaction will close in early fiscal 2012.
CreditSights Inc. estimated that the international bakery and North American refrigerated dough businesses, also up for sale, could bring as much as $800 million more. Sara Lee said last month it was evaluating strategic options for the units. The moves will help Sara Lee's coffee and meat businesses gain “the best platform for a strong and independent future,” the company said on May 5.
Sara Lee was approached by suitors including Leon Black's Apollo Global Management LLC, JBS SA and KKR & Co. beginning last year. The board asked for higher offers only to turn them down later, according to people with knowledge of the negotiations. The credit swaps reached as high as 311.8 on Jan. 25. Sara Lee has a market value of about $11 billion.
“The meats business has been the center of the takeover speculation for the individual businesses and this adjustment will make it a more likely takeover target in the short-run,” Christopher Growe, an analyst at Stifel Nicolaus & Co. in St. Louis, said in a June 14 note to clients.
Private equity has been interested in packaged meats businesses, and spinning out the coffee business instead of the meats means a buyer could pick up the plan instead of waiting till the spinoff is completed, according to Moody's Weddington.
“It does create a clearer picture and a clearer path that could translate to a higher offer,” Weddington said in a telephone interview. “There are LBO screens that this just probably moved very high up on the list now. This transaction may be clearing the way for the company as a target now to potential investors.”