Heinz prices $3bn bond at 4.5% yield, market overly bullish?

High Yield Bond Market vs S&P500 2013-03-25Enlarge Graph

Heinz priced today its bond backing the leveraged buyout (LBO) by Warren Buffet’s Berkshire Hathaway. The issue carries extremely aggressive terms not common to the market. While part of the hype is that the company will now be owned by Warren Buffet, the terms are just too aggressive and cheap.

The 7.5 year bond priced at par with a 4.25% coupon, which is a mere 3% over the Treasury bond with the same maturity. To put in perspective how cheap this yield is, the bond was rated BB- by S&P and B1 by Moody’s (a low BB and a high single B). As of yesterday, the 10 year BB index had a spread to Treasuries of 3.4% and the 10 year B index was at 4.6%, so on average a 10 year bond rated in between the two should have a spread of approximately 4%. The spread from a 7.5 year bond to a 10 year bond is approximately 0.5%, so the expected spread for the Heinz bond should have been 3.5%. The 0.5% is the equivalent to at least “one upgrade” in the rating, so the market pretty much treated the bond as a BB rated bond.

Additionally, the bond carries a two year call protection period – a completely off market term. For several years, market terms have offered a non-call period equal to half of the bond’s life, with the first call at par value plus half of the coupon. In some cases, the non-call period is one year less than half the life, but the first call is at par plus 75% of the coupon. The Heinz bond has a first call after two years at par plus 50% of the coupon.

Leverage is also very high, even compared to other recent LBOs. Assuming a projected twelve-month EBITDA1 $2b (in April 2013), the financing structure is leveraged 6x through the bond. Most recent LBOs have been 4.5x, on average. A multiple of 6.0x is among the top five of all LBOs.

Another sign of over bullishness: the bond was originally $2.1 billion, but was upsized to $3 billion after initial talks with investors. A positive point, though, is the fact that the bond is secured, unlike most bonds issued. Nonetheless, the bond is secured on a second line basis of $9 billion in leveraged loans (4.5x) that have payment priority. That is more turns of debt than most BB rated companies have in their entire capital structure.

Despite the Warren Buffet halo over this transaction, the coming days will tell if the market will continue or if this was the final plate. Investors in HYG and JNK may have experienced recent gains, but a further drop in yields (that would fuel price increases) is very unlikely. In the short term, the risk is much larger. Investors could decrease their interest rate exposure by investing in shorter maturity bonds, such as JNKS, or by investing in leveraged loan ETFs (e.g. SNLN, BKLN), whose floating rates protects their price from increases in interest.

  1. Earnings before interest, tax, depreciation and amortization.