Traders are pushing derivatives linked to Procter & GambleCo. debt to the riskiest level relative to Colgate-Palmolive Co.and lower-rated Unilever since 2009 on concern that investor BillAckman will pressure the company to reward shareholders at lenders'expense.

The cost to protect bonds of the world's largest consumer-goodsmaker from default has increased 10.2 basis points to 0.62percentage point yesterday in New York since July 11, after Ackmanbought a $1.8 billion stake in P&G. While the stock has sincegained 5.6 percent as bullish options wagers surge, bonds of themaker of Tide, Pampers and Crest are underperforming as profitmargins narrow and sales growth decelerates to the slowest since2009.

Ackman may persuade management to reinstate its share repurchaseprogram with debt-sale proceeds, according to bond research firmGimme Credit LLC, after its stock fell almost 10 percent from the2012 high. Cincinnati-based P&G's swaps were less expensivethan those of Colgate and Unilever a year ago.

“It's obviously a concern,” said Alan Shepard, a fixed-incomeanalyst at Madison Investment Holdings Inc., which oversees about$16 billion and holds P&G bonds. Ackman has a history of“wanting to release shareholder value without too much concern fromwhere the bondholders stand,” he said in a telephone interview fromMadison, Wisconsin.

Credit-default swaps on P&G debt are up from this year's lowof 48 basis points on April 3, according to prices compiled byBloomberg. It now costs about $62,000 annually to protect $10million of P&G debt, the most since July 2009. Swaps linked toColgate traded at 44 basis points today with contracts on Unileverat 35.

P&G obligations have also trailed the returns of AA ratedcorporate debt with board members dissatisfied with Chief ExecutiveOfficer Robert McDonald's performance discussing a possibleleadership change, according to people familiar with the situationwho asked not to be identified because the matter is private.

The company's board said yesterday that it unanimously supportsMcDonald and his plan to improve the company's results. Paul Fox, aspokesman for P&G, declined to comment on future corporateactions.

P&G Stake

The company's debt has returned 3.37 percent this year throughJuly 11, versus 5.01 percent for all AA corporate securities,according to Barclays Plc index data. P&G is rated Aa3 byMoody's Investors Service and an equivalent AA- at Standard &Poor's. Unilever is one level lower, A1 by Moody's and A+ atS&P.

Ackman didn't respond to requests for comment on how P&Gshould increase shareholder value. He revealed at the DeliveringAlpha conference produced by television station CNBC andInstitutional Investor Inc. in New York yesterday that his fundowns $1.8 billion of the company's shares.

The 46-year-old Ackman is known for investing in companies hedeems undervalued and urging changes he says will improveshareholder returns.

He purchased a stake in McDonald's Corp. in 2005 and helpedpressure the world's largest restaurant chain to boost its dividendby 50 percent in September 2007. The investor also helped tosuccessfully persuade Wendy's International Inc. to spin off itsTim Hortons Inc. doughnut business in 2006, leading Standard &Poor's to cut Wendy's credit rating to junk.

After Target Corp. rejected Ackman's suggestion to spin off theland beneath its stores as a publicly traded real estate investmenttrust, the second-largest U.S. discount retailer behind Wal-MartStores Inc. said it favored selling its credit-card business, whichAckman supported. The chain also sold $4 billion of bonds to raisefunds for stock buybacks he'd sought.

P&G could borrow $20 billion to repurchase stock andprobably still remain “a strong investment grade credit,” GimmeCredit analyst Carol Levenson said in an e-mail message. Ackman'sstake signals that the “pressure to do some kind of financialengineering is nearly inevitable, and nine times out of ten thiswould be negative for bondholders,” she said.

The company suspended stock repurchases after it said it spent$2.3 billion on its shares in the first calendar quarter.

Undervalued Companies

P&G considers its credit rating important, Chief FinancialOfficer Jon Moeller said at the Deutsche Bank Consumer Conferenceon June 20. The company decided to suspend share repurchases toprotect itself from downgrades, he said.

“Anytime you get an activist like Ackman involved, then therisks do go up,” said Thomas Chow, a money manager at DelawareInvestments in Philadelphia with about $170 billion undermanagement. While Ackman probably will need extra shareholdersupport to influence management, “the ability of Procter &Gamble to access the market and fund shareholder-oriented activitythrough the debt markets is probably pretty high,” he said.

Shares of P&G are down 0.4 percent this year includingdividend payments, compared with a 10.8 percent gain for theS&P 500 index. The stock has increased 20 percent over the pastfive years, compared with a 49 percent rise in the 41-memberS&P 500 Consumer Staples Sector index.

P&G's ratio of enterprise value to earnings before interest,taxes, depreciation and amortization of 11.34 times is less thanthe average of 12.47 among the world's largest household productsmakers. Sales growth at the company declined for the third straightquarter to 1.51 percent in the period ended March 31, the slowestpace since 2009.

Market share for the world leader in both hair and laundry carehas also declined for two years as Unilever expanded, Bloombergdata show.

“We all know that Procter & Gamble is not performing up toexpectations, and patience from shareholders has been wearingthin,” Edward Mui, an analyst at CreditSights Inc. in New York,said in a telephone interview. “When a company moves towardaggressive shareholder-friendly actions, it usually comes at theexpense of bondholders, whether it comes in the form ofdeteriorating credit metrics or asset coverage.”

Cash Use

P&G's ratio of total debt to Ebitda was 1.8 in the mostrecent quarter, compared with 1.72 a year ago and 2.4 in 2006,according to data compiled by Bloomberg. Colgate, the world'slargest toothpaste maker, has a ratio of 1.16 with London- andRotterdam-based Unilever at 1.84 last year, Bloomberg datashow.

Bondholders may still benefit from Ackman's involvement inP&G if he helps spur revenue growth or if management respondsto his ideas by divesting brands such as pet-food maker Iams or theDuracell battery unit without handing proceeds directly toshareholders, Mui said.

The extra cash produced by any strategic change probably won'tbe used to pay down debt, according to Mark Pibl, head of creditstrategy at broker-dealer Cortview Capital Securities LLC.

“In that respect, it hurts the credit,” he said.

Bloomberg News'

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