Walgreens bonds jump amid CoC talk
Long-dated bonds issued by Walgreens Boots have been on a tear since Friday amid talk that the pharmacy chain's potential new owner may be forced to redeem those securities above par.
The 4.5% 2034s, 4.8% 2044s, 4.65% 2046s and 4.1% 2050s have rallied anywhere between seven and 16 points since last Thursday, the day before the Ba3/BB- rated Walgreens said it had agreed to be acquired by private equity firm Sycamore in a transaction valued up to US$23.7bn.
Those low-coupon bonds were issued when Walgreens was still an investment-grade credit, but they had recently been trading anywhere between 75 and 84 cents on the dollar as the company struggled with litigation related to the opioid crisis, high leverage and declining operating profits.
But Sycamore's planned buyout now has some buyside accounts looking at the bonds' change-of-control provisions, which could force the borrower to buy them back at a much higher 101.00 price.
Whether those provisions are triggered or not will partly depend on how the rating agencies react to Walgreens' acquisition, which is slated to close in the fourth quarter.
The language around the change-of-control provisions differs slightly from bond to bond. But in the case of the 2034s, 2044s, 2046s and 2050s, two events have to happen to force the borrower to exercise that option. First, a change of control has to occur, and second at least two rating agencies must downgrade Walgreens in response to the acquisition.
While those new ratings must also be below investment grade, it doesn't necessarily mean that the change-of-control trigger only applies to companies that are demoted to junk from investment-grade.
That Walgreens is already rated junk by both agencies does not invalidate the change of control provision, James Goldstein, head retail analyst at CreditSights, said on Friday.
"The ratings trigger only requires that both rating agencies downgrade bond ratings by at least one notch, and that the resulting ratings are sub-IG," he said in reference to the 2044s.
According to the original prospectuses for the 2046s and 2050s, all three major rating agencies had to downgrade the credit before the borrower was forced to exercise the change-of-control put on those bonds.
But Fitch was struck from that requirement after it withdrew its ratings in 2021, say CreditSights analysts.
Heading for a downgrade?
The conditions to trigger a change-of-control put now seem more likely.
On Friday, Moody's put Walgreens on review for a downgrade, while S&P placed the issuer on CreditWatch negative. Both agencies cite concerns about the company's shift from public to private ownership and the likely increase in leverage as result of the acquisition.
"The bigger issue is whether Sycamore can avoid the CoC by avoiding the ratings downgrade altogether," Goldstein said last week.
Indeed, Sycamore has an incentive to keep the bonds on Walgreens' books.
"Part of the value is keeping that low coupon debt outstanding," said an investor. "It is like getting a cheap loan."
Goldstein said last week that Sycamore could potentially tempt one of the agencies to leave the existing ratings intact by offering some sort of credit enhancement on the bonds.
Sponsors have been able to avoid a 101 buyback in the past, but typically they have done so before the acquisition was announced, Goldstein noted in a report today.
"This leaves the potential that Sycamore has another trick up its sleeve (although we admit to not seeing a good one in terms of a CoC defeat), or the possibility that Sycamore simply isn't concerned with the incremental interest cost in the context of the US$23bn EV transaction."