Boots’ bargain 3-for-2 bond offer
Boots invented the three-for-the-price-of-two offer. Now in a clever deal that many finance directors will hope to copy, the chemists’ new owners have paid off a chunk of its debt on just that basis.
Alliance Boots, as the chain is known since the £11bn buy-out two years ago, has bought in more than £400m of its own bonds at less than two-thirds of face value, pocketing the difference as profit.
It is a clever trick that depends not only on the directors having a more optimistic view of the company than its investors – most boards fall into that trap – but having the financial clout to implement it.
It is a cunning game of poker because if bondholders value the debt at just 62p in the pound that suggests grave doubts about the company’s ability to pay. Directors have to allow the investors to think that, even though they actually have the cash to redeem the bonds.
But because Boots has no quoted equity since the buy-out, there is no risk of the share price being depressed by the worry over its ability to pay, simply the danger its credit rating is damaged and the cost of raising new finance rises. Pulling off the bond buy-in should allay such fears.
Buying in bonds is not the same as companies buying their own shares, an operation loved by the big banks before they realised they were bust. Most companies doing buy-backs in recent years have wasted cash they now wish they still had to purchase shares in the market at more than their current price. Such moves greatly increased gearing and had no effect in stopping share prices falling.
But buying in bonds at below par value creates instant value. Purchasing £400m of debt for £260m, say, reduces net debt by the £140m difference and adds £140m to reserves, doubly reducing gearing.
That should help Alliance Boots’s rating on the £9bn of debt taken on for the KKR-led buy-out. By issuing so much debt in June 2007, just before the credit crunch, marginal lenders were no doubt encouraged to buy bonds and no doubt now wish they had not – hence their eagerness to sell out so cheaply.
Some big banks are probably among the distressed potential sellers. Ideally they would hold the bonds until redemption in full – as many are doing with their sub-prime loans instead of making provisions – but this is not an ideal world. Boots has cleverly taken advantage of their distress.
