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Walgreens Boots Alliance’s shareholders are being offered a 63 per cent premium if they sell to private equity firm Sycamore Partners. But some of the company’s creditors could be in line for a similar bonanza.
Back when the drugstore chain — which includes UK high-street stalwart Boots — boasted a market capitalisation in the tens of billions of dollars, it regularly issued highly rated debt, taking advantage of low interest rates. One bond in April 2020 came with a 4.1 per cent coupon and a 30-year maturity. A few weeks ago, those bonds were trading for just 65 cents on the dollar, reflecting that modest coupon and Walgreens’ glum prospects.
Sycamore’s offer could save the day for those bondholders. Investors and lawyers are poring over documents to see what borrowings Walgreens can leave outstanding, and which must be retired at face value, to be refinanced with more expensive paper. Essentially, if Walgreens’ credit rating falls to “junk” status, bondholders could force the company to buy back the bonds at par.
Investors seem to think Sycamore will be forced to buy them out as rating agencies have already warned on downgrades. The price of the 2050 notes has risen to more than 90 cents. Sycamore, though, has its own game to play: the less cash Walgreens can spend on interest, the more there is to bolster its would-be owner’s equity returns.
Sycamore’s disclosures so far suggest its financing structure is pretty aggressive. Out of an all-in cost of $23.7bn, Sycamore is committing just $2.5bn of equity. Walgreens chair Stefano Pessina has pledged to rollover his existing 17 per cent stake, worth as much as $2.1bn.
Sycamore says it has secured roughly $20bn in firm debt and preferred stock commitments from a series of large banks and well-known private credit firms. Assuming that comes with an average 10 per cent interest rate, Walgreens needs to find $2bn a year. That’s about half of the cash analysts expect its operations to generate in its next financial year, after taking out capital expenditure, according to LSEG.
There’s room for fancy footwork. Some of that debt is credit lines that might not be drawn. Walgreens will try to sell assets, which could cut its debts, although also sacrifice the attached cash flow. It may also issue debt repayable in more debt — so-called pay-in-kind loans, though these can turn out to be costly in the long run. Sycamore could even throw in more equity to avoid the triggering debt downgrade.
Most likely, Sycamore will just buy the existing bonds back — and try to get the best deal it can issuing more flexible, albeit more expensive, debt. Shareholders, who have lost about two-thirds of their investment in the past five years, will probably be grateful to see a deal go through at all — even if it is a group of bondholders who take home the sweetest premium.
This article has been amended to reflect that Walgreens would need to find $2bn a year to service interest payments, not $200mn
