Are Best Buy Bonds Best Buys?

Many investors are equity oriented. They see an LBO announced for a company which stock they own and they are cheered. After all, the private equity group has probably announced it will pay above current market price for the shares. But to do this, the new private owners must barrow to complete the purchase. This is not good news for bondholders. Best Buy has been in the news not only because of its poor earnings, but because its founder, Richard Schulze, wishes to take the company private. This was the subject of our Making Sense report: Best Buy has been a company in the news in recent weeks. We have not covered the story because BBY has only three bonds issues outstanding. However, what could play out with BBY presents us with the opportunity to discuss how creditors might be affected when a company is taken private. Founder, Richard Schulze, is considering a takeover bid for Best Buy and taking the company private. Doing so would trigger a “poison put” on bonds. A poison put requires a company to buy back bonds from investors, usually at a premium (101 in this case) upon change of control of the company. Why would investors want to put back their bonds just because a company goes private? When a company is taken private, it is usually done via a leveraged buy-out. The new owners borrow money, usually via bank loans, to purchase the company. Bank loans are usually secured by specific assets. Secured loans are senior to even senior debt as senior debt is unsecured (they are general obligations). Another concern is that, a private company does not have to report earnings. Investors have no idea what its balance sheet looks like. By owning bonds of a company which has been taken over via an LBO, you are now a creditor of a company which just had a ton of debt loaded on its balance sheet and you are now subordinate to all of this debt. To make matters worse, because there is no financial reporting, it is impossible for bondholders to assess their risk. Since LBOs can be considered negative consequences for fixed income investors, many bonds are issued with poison puts. If the company in question is taken over (via a leveraged deal or otherwise), investors can put the bonds back to the company at the stated put price. A poison put can also help investors assess the street consensus opinion of the likelihood of a takeover of a company. Let’s look at BBY’s three bonds and where they are trading: Best Buy (BBY) 6.75% due 7/15/13 Bid: 102.75 Offer: None offered. Best Buy (BBY) 3.75% due 3/15/16 Bid: 92.956 Offer: 93.450 Best Buy (BBY) 5.50% due 3/15/21 Bid: 90.052 Offer: 90.625. Obviously the market is not pricing the bonds as if a takeover would occur. If it was, the prices would be much closer to the 101 poison put price. This means investors have to ask themselves a question: Do I feel lucky? Why lucky? If one buys BBY 2016 and 2021 bonds, one actually wants a Schulze takeover to occur, as one could put bonds back at $101. If the deal does not happen, one owns bonds, not due to mature for a number of years, with a faltering business model. What about the 6.76% due 7/15/13? When last we looked, there were no bonds offered at any price, but let’s assume an offering materialized at 103.25. That would give as yield of 2.578%. Prices of the 2013 BBY paper indicates that market participants a deal will occur and/or that, even if a deal occurs 2013 bonds will mature on schedule. The way we see it is: The 2013 BBY bonds might be good for aggressive investors to pick up short-term yield. Apparently other market participants share our view as no one was willing to sell bonds when we last looked. The longer-dated bonds might be offer an opportunity to speculate on a possible takeover, but if it does not occur, you be hitching your wagon to a falling star. The market is forecasting the latter. Tom Byrne tom@bond-squad.com. www.bond-squad.com www.mksense.blogspot.com 347-927-7823 Twitter: @Bond_Squad Disclaimer: The opinions expressed in this publication are those of the author. They are not, nor should they be considered solicitations to purchase or sell securities.