Bondholders Skeptical of Best Buy Offer

Trading in securities with poison put suggests investors don’t put much stock in Schulze purchase.

Best Buy Co. founder Richard Schulze says his takeover offer gives the world’s largest electronics retailer its best shot at competing with Inc. and Wal-Mart Stores Inc. Bondholders aren’t convinced.

Best Buy has $1.5 billion of securities that have a so-called poison put, which requires the company to purchase the notes at 101 cents on the dollar in the event of an acquisition combined with a ratings downgrade. A total of $1 billion of that debt is trading as much as 11 cents below that repurchase price, indicating bondholders believe a buyout isn’t imminent.

Talks between Schulze, 71, and Richfield, Minnesota-based Best Buy broke down on Aug. 19 and resumed two days later after the company posted quarterly earnings that trailed analysts’ estimates. The retailer has been closing big-box stores and paring jobs to generate savings for promotions and training store employees as it struggles to convince investors that its strategy is still relevant.

“We don’t think the credit market is putting much stock in the transaction,” Joscelyn MacKay, a credit analyst at Morningstar Inc. in Chicago, said in a telephone interview. “There are just a lot of outside issues that we think are hurdles to get this deal done.”

Online retailers like Amazon are willing to accept lower margins than its brick and mortar counterparts, putting pressure on companies like Best Buy to defend market share and reduce costs through closing stores, MacKay said.

Bruce Hight, a Best Buy spokesman, and David Reno, a spokesman for Schulze, both declined to comment.

Best Buy’s $650 million of 5.5 percent senior unsecured bonds due in March 2021 traded at 90 cents on the dollar to yield 7.08 percent yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Its $350 million of 3.75 percent notes due March 2016 fell to 92.8 cents, yielding 6.06 percent.

“Any Schulze-led buyout would require incurring a large amount of debt that would require further ratings downgrades,” Alexander Diaz-Matos, an analyst at the credit research firm Covenant Review LLC, said in a telephone interview. “Even if the bonds are rated below investment-grade by all three ratings agencies prior to a buyout, it’s extremely likely given the leverage required, a further downgrade would take place.”

Without the buyout, “you’re left without a 101 percent change of control right and a deteriorating business,” he said.


Bond Coupons

Best Buy’s $500 million of 6.75 percent bonds due in July 2013 compensate investors for downgrades, with the interest rate increasing 25 basis points for every level below junk the rating falls until it reaches B, according to a Dec. 15, 2008, prospectus. Those bonds are trading at 103.1 cents, from as high as 107.3 cents on Oct. 11, Trace data show. Investors in that debt are less concerned with buyout speculation as the maturity date ticks closer, according to Diaz-Matos.

Once a $29 billion company, Best Buy has wiped out almost 80 percent of its market value as it lost sales to Internet-based retailers such as and discount stores like Wal-Mart. It posted a net loss of $1.23 billion on revenue of $50.7 billion for the year that ended in March, its first annual loss since 1991, data compiled by Bloomberg show.

Best Buy and Schulze reached an agreement Aug. 27 allowing him to conduct due diligence and bring a fully financed, definitive proposal to the company within 60 days. If that offer is rejected, he must wait until January to pursue an acquisition through other means, the company said in a statement.

“The board probably was frightened by the falling stock price and felt that to cover itself it had to agree to allow Mr. Schulze to make an offer,” Carol Levenson, an analyst at debt-research firm Gimme Credit LLC in Chicago, said in an e-mail. “Perhaps they are calling his bluff about his ability to raise the cash.”

The agreement gave Schulze access to financial data that may help him line up private-equity firms he needs to fund a takeover of the company he founded more than four decades ago and left in June.

Best Buy closed at $17.86 yesterday in New York. The shares have declined 24 percent this year and trade below Schulze’s Aug. 6 offer of as much as $26 a share, or about $9 billion. That “tells you folks don’t think it’s likely,” Noel Hebert, chief investment officer at Bethlehem, Pennsylvania-based Concannon Wealth Management LLC, said in an e-mail.


Like Junk

Traders already are treating some Best Buy debt like junk. At 7.08 percent, the yield on the 5.5 percent notes due March 2021 were higher than the average yield on BB rated bonds at 5.64 percent on Aug. 27, according to Bank of America Merrill Lynch index data.

Standard & Poor’s lowered Best Buy’s credit rating to BB+ from BBB- on Aug. 6, as a result of Schulze’s pitch. Moody’s Investors Services gives the company a Baa2 grade, two steps above high-yield.

“The transaction, if completed, would materially weaken Best Buy’s credit protection metrics because we believe it will add a significant amount of debt,” S&P analysts Jayne Ross and Charles Pinson-Rose wrote in the note.

Even without the buyout, “management still hasn’t been able to keep the leverage in line,” MacKay said. “This is a company that is going south. Yes, this company is investment-grade right now, but in 2016, this paper might be more like a single B.”

The average yield on single B bonds was 7.21 percent Aug. 27, according to Bank of America Merrill Lynch index data.

Best Buy named Hubert Joly as its new chief executive officer on Aug. 20 to oversee a turnaround plan that entails shifting to smaller locations in a bid to fend off rivals.

The next day, the company reported second-quarter profit that trailed analysts’ estimates and will no longer provide an earnings forecast as sales of computers and televisions dropped. Excluding restructuring charges and other items, profit was 20 cents a share, the company said, missing analysts’ average estimate of 31 cents. Revenue of $10.5 billion last quarter is down from $11.3 billion in the same period last year.

The company’s leverage, or adjusted total debt to earnings before interest, taxes, depreciation and amortization, was 1.9 times May 5, according to the S&P rating report. That will increase to 3.8 times after a $9 billion transaction, the rating company wrote.


Credit Swaps

Credit swaps protecting against the company’s default for five years have climbed to 14.3 percent upfront yesterday, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That’s in addition to 5 percent a year, meaning it would cost $1.43 million initially and $500,000 annually to protect $10 million of Best Buy’s debt.

The credit-swap prices have climbed to levels implying the debt is rated B3, according to Moody’s Corp.’s capital markets research group, seven steps below its actual rating. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

“It’s a very, very tough deal, especially given where the CDS are trading,” Melissa Weiler, a money manager who helps oversee $10 billion at Crescent Capital Group LP, said in a telephone interview. “Consumers still like to go to a store to look at and touch electronics. But the size of Best Buy stores needs to shrink and it needs to significantly improve its business online. It is a business that can survive, it is just going to have to dramatically change how it operates.”



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