Fortune Brands - The Debt Details

Given the news on Fortune Brands, I figured it might be worth having another look at their debt, as it will be most affected (at least in a possibly negative sense) by the potential transaction.  First we will review the outstanding indentures and see which notes were issued under them (this will define the base covenants applicable to each series of notes), then we will look at other features contained within the notes to “safeguard” debt investors.  Finally, we will determine the “pain priority”.

I.  INDENTURES

Indenture dated as of April 15, 1999:
$400,000,000 aggregate principal amount of 3.000% notes due June 01, 2012. Issues 11/09; MW+40
$500,000,000 aggregate principal amount of 6.375% notes due June 15, 2014 - Issued 6/09; MW+50
$750,000,000 aggregate principal amount of 5.125% notes due Jan 15, 2011 - issued 1/06; MW+15
$950,000,000 aggregate principal amount of 5.375% notes due Jan 15, 2016 - issued 1/06; MW+20
$300,000,000 aggregate principal amount of 5.875% notes due Jan 15, 2036 - issued 1/06; MW+25
$300,000,000 aggregate principal amount of 4.875% notes due Dec 1, 2013 - issued 11/03; MW+12.5

Indenture dated as of July 15, 1988:
$200,000,000 aggregate principal amount of 6.625% notes due June 15, 2014 - Issued 6/98; MW+15

The covenants (base covenants) contained within the two indentures are identical, and will, therefore, be addressed as one.

Common (“base”) Covenants:

Limitations on Merger:  The indenture provides that if we merge or consolidate with or into any other corporation or we transfer substantially all of our assets to any other corporation, and as a result any of our property or the property of a Restricted Subsidiary would become subject to any mortgage, we will simultaneously with or prior to such transaction secure the debt securities by a prior lien on such property. (Section 8.03). If we merge or consolidate with any other corporation or we transfer substantially all of our assets to any other corporation, the successor corporation shall be substituted as obligor under the indenture. (Sections 8.01 and 8.02).

Restrictions on Transfers of Property:   Neither we nor any Restricted Subsidiary may transfer or lease any major facility to any Subsidiary not considered a “Restricted Subsidiary” for any of the reasons described in the first sentence of the Restricted Subsidiary definition in the “Definitions” paragraph above. (Section 10.08).

Not too much, is there?  Unfortunately, these covenants aren’t going to help you.  I have seen successor obligor used in creative ways in the past.  Might be worth a look into, but don’t think it will really help.  Basis for the argument was the Sharon Steel case.

II.  OTHER FEATURES:

Change of Control.

$400,000,000 aggregate principal amount of 3.000% notes due June 1, 2012. Issues 11/09

$500,000,000 aggregate principal amount of 6.375% notes due June 15, 2014 - Issued 6/09

Definitions:

Change of Control Offer

If a change of control triggering event occurs with respect to the notes, unless we have exercised our option to redeem the notes as described above, we will be required to make an offer (a “change of control offer”) to each holder of the notes with respect to which a change of control triggering event has occurred to repurchase all or any part (equal to $2,000 or any multiple of $1,000 in excess thereof) of that holder’s notes on the terms set forth in the notes. In a change of control offer, we will be required to offer payment in cash equal to 101% of the aggregate principal amount of notes repurchased, plus accrued and unpaid interest, if any, on the notes repurchased to the date of repurchase (a “change of control payment”).

“Change of control triggering event” with respect to the notes means the occurrence of both a change of control and a rating event with respect to the notes.

“Change of control” means the occurrence of any of the following: (1) the direct or indirect sale, lease, transfer, conveyance or other disposition (other than by way of merger or consolidation), in one or more series of related transactions, of all or substantially all of our assets and the assets of our subsidiaries, taken as a whole, to any person, other than our company or one of our subsidiaries; (2) the consummation of any transaction (including, without limitation, any merger or consolidation) the result of which is that any person becomes the beneficial owner (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of more than 50% of our outstanding voting stock or other voting stock into which our voting stock is reclassified, consolidated, exchanged or changed measured by voting power rather than number of shares; (3) we consolidate with, or merge with or into, any person, or any person consolidates with, or merges with or into, us, in any such event pursuant to a transaction in which any of our outstanding voting stock or the voting stock of such other person is converted into or exchanged for cash, securities or other property, other than any such transaction where the shares of our voting stock outstanding immediately prior to such transaction constitute, or are converted into or exchanged for, a majority of the voting stock of the surviving person or any direct or indirect parent company of the surviving person, immediately after giving effect to such transaction; (4) the first day on which a majority of the members of our Board of Directors are not continuing directors; or (5) the adoption of a plan relating to our liquidation or dissolution.

Notwithstanding the foregoing, a transaction will not be deemed to involve a change of control under clause (2) above if (i) we become a direct or indirect wholly-owned subsidiary of a holding company and (ii)(A) the direct or indirect holders of the voting stock of such holding company immediately following that transaction are substantially the same as the holders of our voting stock immediately prior to that transaction or (B) immediately following that transaction no person (other than a holding company satisfying the requirements of this sentence) is the beneficial owner, directly or indirectly, of more than 50% of the voting stock of such holding company. The term “person,” as used in this definition, has the meaning given thereto in Section 13(d)(3) of the Exchange Act.

“Rating event” means the rating on the notes is lowered by each of the rating agencies then rating the notes and the notes are rated below an investment grade rating by each of the rating agencies then rating the notes on any day within the 60-day period...

Unfortunately, I don’t think this will help either.  The key term is going to be “all or substantially all” which has never been defined (no “bright line”) and will be determined after litigation.  As well, a quick look at the possible break up does not infer an “all or substantially all” scenario.

Coupon Steps (Interest Rate Adjustment)

$500,000,000 aggregate principal amount of 6.375% notes due June 15, 2014 - Issued 6/09

Each adjustment required by any decrease or increase in a rating set forth above, whether occasioned by the action of Moody’s or S&P (or, in either case, a substitute rating agency), shall be made independent of (and in addition to) any and all other adjustments. In no event shall (1) the interest rate for the notes be reduced to below the interest rate payable on the notes on the date of their issuance or (2) the total increase in the interest rate on the notes exceed 2.00% above the interest rate payable on the notes on the date of their issuance.

Now we’re talking.  As long as you are going to get hit, might as well get a few more coins for your bruises.  I think that unless there is some dividend back to FO to tender for debt, you are looking at high yield ratings.

III.  PAIN PRIORITY

Least to worst pain:
6.375% due 2014 - coupon steps and CoC (very little value in CoC IMHO)
3.000% due 2012 - CoC (again, little value, but there could be creative legal arguments)
Everything Else
5.875% due 2036 - nothing but yuck duration.  Ouch.

LEVELS:
FO 3.000 12    /+115  
FO 4.875 13 215 3yr
FO 6.375 14 235/231 5yr
FO 5.875 36 285-245

If you’re looking, 14s all the way. If you’re holding, hope you have the 14s or would consider shortening into them.

Links:

Sharon Steel

Even Better Sharon Steel

Tyco Split Up and Bondholders  - I was part of this group as my old shop was a plaintiff.  Good read!

Get ready.  If you're going to fight, its going to take time.

Fortune Brands - Mea Culpa

I stated in my post on FO that if I HAD to own the name, I would swap from 14s to 16s and take out $5.  Seemed reasonable at the time and for the levels being talked about.  One problem:

Interest rate adjustment:  The interest rate payable on the notes will be subject to adjustment from time to time if our debt rating is downgraded (or downgraded and subsequently upgraded), as set forth in “Description of the Notes — Interest Rate Adjustment."

Change of control offer:  If a change of control triggering event occurs with respect to the notes, each holder of the notes may require us to purchase all or a portion of such holder’s notes at a price equal to 101% of the principal amount, plus accrued interest, if any, to the date of purchase. See “Description of the Notes — Change of Control Offer.” 

The 16s do not include the steps or the COC.  Since I do not believe the COC would be triggered by a spin of a business line. I will ignore this and focus on the steps.  These will help support the bonds should FO spin a large business line and retain the debt.

Bad Michael, Bad! Inexcusable error.

Fortune Brands - No Fortune for Bondholders - Gonna Be Teed Off

I have been thinking about Fortune Brands recently and the Pershing activist position (yes, the title is my attempt at humor).  Here's the scoop from WSJ:

Fortune Brands Inc., the maker of Jim Beam bourbon and Moen faucets, is now more likely to cooperate with activist shareholder William Ackman on a plan to split up the company's three business units, people familiar with the matter said.

There isn't any guarantee that efforts to spin off or sell the golf-equipment, spirits and home-products businesses will succeed, given the complexity inherent in untangling and valuing the three divisions, the people cautioned.

Fortune also may eventually decide against working with Mr. Ackman, whose Pershing Square Capital Management owns about 11% of the company, the people said. But the people familiar with the matter described the interaction between the two sides as "constructive" rather than confrontational.

Fortune's management is open to the idea of breaking up the Deerfield, Ill., company and sees Mr. Ackman's interest as an opportunity to test the market for the different assets, one of the people familiar with the matter said. Fortune also is more optimistic that its businesses will get better value if sold amid what it views as an economic recovery, the person added.

Mr. Ackman's hedge fund disclosed its stake in the conglomerate in early October.

If the two parties are able to reach an agreement they could avoid the costs and distraction of a proxy fight. Fortune could decide to adopt a "poison pill" or shareholder rights plan but has so far decided against it because it is cooperating with Mr. Ackman, the people familiar with the matter said.

Mr. Ackman often seeks changes at companies whose shares he feels are underperforming and has been involved in several high-profile proxy fights, Last year, he made an unsuccessful bid to win five seats on the board of Target Corp. Mr. Ackman also disclosed a significant stake in J.C. Penney Co. last month, prompting the retailer to adopt takeover defenses.

Several parties could be interested in the different businesses of Fortune and some have expressed an interest already, the people familiar with the matter said. Diageo PLC and Bacardi Ltd., which compete with Fortune's spirits business, would likely take a look at the assets if they were put on the block, the people said.

The division is the largest by operating income and had $2.5 billion in 2009 annual sales.

Pre-Ackman announcement, long fortune's traded about par.  Now, 92-94ish.  Depending on the level of cooperation and the path taken by the company, this could get interesting for bondholders.

I was involved in a similar situation with Tyco.  The company under the amazing foresight of Ed Breen (can you just hear the sarcasm?) split the company into three separate pieces.  Bondholders winced, screamed and howled about a sale of "all or substantially all" of the assets.  I was among a group of bondholders who decided to pursue litigation.  All or substantially all is difficult to define (there is no "bright line" as to what it means) and can involve years of litigation.  A synopsis of the Tyco resolution can be found here: Tyco Bond Resolution

Should the company spin-out the spirits business and not put debt on it to redeem some existing debt, bondholders will get whacked.  Here's the other problem if done right and the lawyers work their magic, this will not be a change of control if FO retains the bonds (successor obligor issue solved), board is intact, "all or substantially all" not an issue...

Bottom line, if you think it is a possibility that FO plays ball with Ackman - price to 4B/5B space.
Here's some levels:
6.375% due 14 ($500MM deal) +250/5yr    @109 - have seen +225/5yr offered
5.375% due 16 ($950MM deal) +325/5yr    @$104 - have seen +275/5yr offered

5.875% due '36 ($300MM deal)+225/30yr   @$92  have seen  +275 bid

Ummm, can you guess which bonds I'd be punting?  See ya long guys - way too much risk for +200ish. If I HAD to hold the name or wanted to optimize my position, I would swap out of the 14s into the 16s, take out $5.

If FO pushes back, bonds could rally from here (depending on what actions they take to pacify Mr. Ackman), if not, depending on structure, they could drop further.  Not exactly my risk/reward cup of tea.

Look for more info from their presentation at Morgan Stanley's retail conference.