Tailor-made solutions: Kraft Foods’ decision to split itself into a snacks company and a North American grocery company required capitalising one of the entities with US$9.6bn in debt. The solution was an intricately sequenced three-part capital markets package, including unique financing structures, making Kraft Foods’ transaction IFR’s Americas Financing Package of the Year.
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On August 4 2011, Kraft Foods Inc announced its intention to become a snacks company called Mondelez International and spin off its grocery assets into a new company named Kraft Foods Group.
The aim was to maximise shareholder value by having each company focus on its core assets: the new Kraft Foods Group’s North American grocery business, expected to generate more than US$18.9bn in annual revenue and an estimated US$3.5bn in Ebitda, and the high-growth snacks business in the renamed parent, Mondelez, generating over US$54bn of annual sales and an estimated US$9bn of Ebitda.
But first, Kraft Inc had to figure out how to capitalise Kraft Foods Group with debt totalling US$9.6bn, while also managing to meet existing debt maturities of its own and without adding to an overall debt load that jeopardised targeted ratings.
Those needs catapulted Kraft’s Treasury team into a six month-long odyssey involving three inter-dependent capital markets exercises and various trips to the loan market.
“It was like landing a 747,” said Darin Aprati, treasurer of Kraft Foods Group. “All three parts [executed in the bond market] had to happen at exactly the right time and in a specific sequence to get the best execution and economics.”
The first capital markets piece in January was a unique US$800m 18-month floating rate note with a mandatory redemption feature – a product never before tested on US investors and one devised by Royal Bank of Scotland’s DCM team as an alternative to Kraft Foods Inc taking on a more expensive bridge loan.
The second was a US$6bn four-tranche bond in May in tough market conditions and the third done in June was a US$3.6bn liability management trade involving a rarely used par-for-par waterfall exchange structure.
One challenge was that US$4.5bn of debt with Kraft Foods Inc (the parent) was maturing in the first half of 2012. Going to term markets for the parent was not an option because of SEC reporting requirements. The company would simply not have been able to compile pro forma financial statements by the respective maturity dates of the debt.
The parent also relied heavily on the commercial paper market for seasonal working capital. That reduced its ability to rely on that market to finance the debt maturities.
The company had specific leverage targets to meet in order achieve a Triple B credit rating for both Mondelez and the new Kraft Foods Group, keeping them in the investment-grade category. And it was not in a position to issue US$9.6bn in debt and then repay it to the parent in the form of a dividend for debt deleveraging.
“The friction costs associated with that debt paydown would have resulted in a higher than targeted leverage ratio for Kraft Foods Group/Mondelez,” said Jennifer Powers, head of DCM at RBS, the only adviser to Kraft that was mandated through all parts of the financing.
Special measures
RBS’s idea of issuing a floater with a special mandatory redemption feature enabled Kraft to access term liquidity before the official spin-off and still meet SEC reporting requirements.
“This solution offered superior economic cost benefits relative to the current bank market because it was an 18-month floater with a mandatory redemption five days prior to the date of the actual spin,” said Powers. “By that time, the company would have completed its term capital raises, providing sufficient amounts of excess cash to pay for the redemption.”
Aprati was convinced by the innovation because it meant much cheaper financing than taking out a bridge.
“If the mandatory redemption feature in a floater catches on, it could become a capital markets solution to bridge loans in large transactions, and that is ground breaking,” he said.
After the US$800m 18-month FRN transaction Kraft Foods Inc went to the bank markets in March and locked in US$4bn in a revolving credit facility from four banks as an interim financing to support the spin-off of the grocery business.
In May, US$3bn was provided by banks to Kraft Foods Group as a five-year permanent revolving credit facility to support its long-term liquidity profile.
The next objective was pricing a US$6bn debut offering for the new Kraft Foods Group spin-off, spread over four maturities and with the aim of establishing liquid pricing benchmarks for the pending exchange offer.
“The US$6bn bond was effectively sized to help us meet our capital structure objectives while also serving as a sound benchmark for the exchange which was the final piece of a very complicated puzzle,” said Aprati.
On the day of announcement, however, US credit markets were swinging wildly after seeing Spanish and Italian borrowing costs soaring to six-month highs because of fears Spain would be forced to seek an EU bailout for its banks.
Scary times
The situation was tackled with skill by the joint active books, Barclays, Citigroup, Goldman Sachs, JP Morgan and RBS. The banks had organised a day of marketing (prior to the formal announcement of the deal) at which management spoke to 67 investors on 16 different conference calls.
Relative value strategy focused on existing US food companies and feedback was used to work out initial valuation levels for the offered bonds.
Orders soon approached US$22bn, illustrating that not all investors were confined to the sidelines by gloomy sovereign news. The book size also suggested the marketing effort was paying off.
Price guidance was Treasuries plus 140bp area on the three-year, plus 165bp area on the five-year, plus 205bp area on the 10-year, and plus 240bp area on the 30-year. All priced 5bp tighter than guidance.
The US$1bn three-year paid a coupon of 1.625%; the US$1bn five-year paid 2.25%; the US$2bn 10-year 3.50%; and the US$2bn 30-year 5.00%. Proceeds were distributed to the parent.
The final step – the most complicated of all – involved pushing an additional US$3.6bn of existing Kraft Foods Inc term debt over to Kraft Foods Group.
The challenge was that leverage at the combined companies was close to the maximum allowed within the desired Triple B rating category, so any liability management transaction that crystallised the premium above par on existing bonds would cause a problem. Management had also told investors they did not plan to access the market again in 2012, making it impossible to tap term debt markets.
The answer was a par-for-par exchange offer, a structure which is a rare sight in the US markets, especially at a time when old, high coupon debt is trading at huge premiums over par.
The usual course in high dollar price exchanges is to give investors a chance to monetise some of the premium price of the old bonds and offset that cost with an associated tax deduction while spreading out the cost over a longer weighted average life of the new bonds.
But to avoid taking on additional debt, Kraft decided to offer investors the chance to take on new par bonds with the same maturity and coupons as the old bonds.
The whole process was structured into individual exchanges for the two largest existing bonds (due 2020 and 2040) and separate exchanges for six other bonds which were to be replaced by new 2018 and 2039 bonds with cash payments adjusted to create comparable values for all investors.
In total, US$3.6bn of new Kraft Foods Group bonds were issued in exchange for US$4.6bn of eight different bonds of the parent that were tendered.
