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updated: 10/28/2012 7:00 AM

SuperValu bonds tumble as shareholders gain

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Bloomberg News

Bonds of SuperValu Inc. that lack protections for investors in a takeover have made the supermarket chain's debt the worst performer among high-yield U.S. food and drug retailers in 2012 even as its shares soar.

SuperValu bonds yield 11.3 percent, up from 8.4 percent last year and at least three percentage points more than the five other issuers in the Bank of America Merrill Lynch High Yield Food & Drug Retail index. The stock, up 63 percent since Oct. 15, traded at $3.00 a share at 11:09 a.m. in New York.

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The retailer, whose senior unsecured debt is rated Caa1 by Moody's Investors Service and B by Standard & Poor's, said Oct. 18 it is in "active dialogue" with several parties about strategic options. A debt-funded, or leveraged, buyout would boost Eden Prairie, Minnesota-based Supervalu's ratio of borrowings to earnings, which last quarter reached a five-year high, reducing the value of its existing debt.

"SuperValu bondholders are exposed to much greater risks in a potential LBO than other retail companies with better change of control protections across their bonds," Alexander Diaz-Matos, the head of investment-grade research at researcher Covenant Review LLC, said in a telephone interview. "It illustrates why covenants matter."

Most of the rising yields reflect the 62 percent of Supervalu's $3.91 billion of bonds that don't require redemption after a takeover, which yield as much as 16 percent.

A private-equity firm would finance a buyout of SuperValu with new debt that would subordinate existing debentures, worsening conditions for bonds without a change of control, said Diaz-Matos. JPMorgan Chase & Co. analyst Carla Casella said in an Oct. 22 note that there's a 50 percent likelihood of an LBO for as much as $5 billion.

"The company has received a number of indications of interest and is in active dialogue with several parties," company spokesman Michael Siemienas wrote in an emailed statement.

The 62 percent of SuperValu notes that lack change of control covenants compares with 23 percent at Safeway Inc. and 33 percent at Kroger Co., according to data compiled by Bloomberg. SuperValu posted a quarterly net loss of $111 million last week.

SuperValu bonds fell after it negotiated a credit agreement in July that eased leverage restraints. It arranged as much as $2.5 billion in loans that allowed the company to rid itself of covenants restricting debt it can have relative to earnings before interest, taxes, depreciation and amortization.

At the same time, the grocery chain planned to accelerate price reductions and cut costs by $250 million over the following two years as part of its strategic review, according to a July 11 statement.

Even if price reductions make a company temporarily more attractive to a potential buyer, that may not last when other retailers catch up, said Evan Mann, a senior bond analyst at Gimme Credit LLC. "Even though you lower your prices, it's not like everyone else is standing still," Mann said. "There's so much competition, it just doesn't seem like such an attractive place to put your money."

Credit default swaps protecting SuperValu debt jumped to 1,166 basis points the next day from 938 and rose as high as 1,656 later that month, according to prices compiled by Bloomberg. They ended yesterday at 1,433, meaning it would cost $1.43 million annually to protect $10 million of debt for 10 years. The contracts pay buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

SuperValu paid $3.8 billion in cash, $2.5 billion in stock and assumed $6.1 billion in debt to acquire Albertsons Inc., the Boise, Idaho-based grocery chain in 2006. That assumed debt, some of which was sold by American Stores Inc., a Salt Lake City company that Albertsons purchased for $13.2 billion in 1999, included the issues that lack change-of-control agreements.

The Albertsons notes also don't have a parent guarantee, which limits liens against the bonds. American Stores notes, which do carry that guarantee, yield between 9.4 percent and 9.6 percent. Most of the Albertsons notes yield more than the 11.3 percent average of the Bank of America Merrill Lynch High Yield CCC and Lower index.

Coupons for most of the Albertsons and American Stores debt are between 7 percent and 8 percent, so SuperValu may leave the debt in place, Casella wrote in the note. She said she expects a buyer to refinance Supervalu's approximately $1.3 billion of bank debt, $173 million of three bond issues due next year and the two bonds with change of control provisions: $490 million of 7.5 percent notes due 2014 and $1 billion of 8 percent notes due 2016.

The value of all the grocer's bonds have fallen to $3.49 billion since the beginning of the year, when they were at $3.65 billion, according to Bank of America Merrill Lynch index data.

The company has reported an aggregate $4 billion in net losses in the five years since 2007, as its stock has fallen from a high of almost $50 a share.

Cerberus Capital Management LP is willing to buy all of SuperValu as it seeks to stymie competing bidders targeting parts of the company, said two people with knowledge of the matter. Cerberus participated in the Albertsons buyout, acquiring 655 of the chain's stores while SuperValu took more than 1,100.

"Once you start down this path, it is hard to turn the ship around and say, 'Never mind, we'll do it all within,'" Noel Hebert, chief investment officer at Bethlehem, Pennsylvania-based Concannon Wealth Management LLC, which oversees about $250 million including SuperValu bonds and stock, said in an email. "They have the cash flow and liquidity to do it, but with the generic consumer still struggling, they are at risk of ceding further ground competitively."

A buyer may try to sell assets, gain liquidity, invest in stores and eventually pay down some debt, Mann said. "It could give them time to orchestrate a turnaround," he said.

Mann said the company started a turnaround when it appointed Wayne Sales, a board member, as chief executive officer, on July 30. The chain said last month it would close 60 stores to preserve cash.

Having a large number of bonds without change of control agreements is a product of the era before the LBO boom of the mid-2000s, Diaz-Matos said. Investors who funded deals such as Verizon Communications Inc. and Vodafone Group Plc's acquisition of Alltel Corp. in 2009 for $5.9 billion in cash and $22.2 billion bought debt that subordinated existing lenders, he said.

"Bondholders were burned pretty hard in the LBO wave of the mid-2000s," Diaz-Matos said. "They increasingly asked for change-of-control protections to be added to their bonds."

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