Home Depot Strikes Back

Richard wrote on December 4th (see here) about a potential gigantic leveraged buyout (LBO) for Home Depot in the US. Since then we have seen the company’s CEO describe the rumours as an ‘unfortunate distraction’ and issue $5bn worth of bonds. So was the bond issuance announced a mere number of days after the LBO rumours a co-incidence ? I’d suggest not.

Typically when a company looks to come to market one of the first questions they are likely to be asked is what they intend to use the proceeds for. On this occasion the company stated use of proceeds was largely the repurchase of shares. This in theory will have a two fold impact, firstly supporting the share price (simple supply & demand economics) and secondly increasing leverage (net debt increases as cash is paid out). For bond investors this is a worrying trend. Leverage typically is not a good thing. The greater the leverage the greater the debt burden and consequently the greater the chance bond investors will struggle to get their money back. As you’d expect credit spreads tend to come under pressure in such scenarios. This year we have seen a long list of companies return cash to shareholders (ITV, Vodafone & Volvo for example) through additional dividends.

Is this trend likely to continue? Well as long as private equity continues to have access to large swathes of capital (currently estimated in excess of $1 trillion) then in a word, yes. As CEOs become increasingly concerned about the potential for their beloved public companies being taken private they are likely to look to return cash to shareholders. Higher equity prices equal more satisfied shareholders and increasingly prohibitive costs for private equity.

As a team this is a trend that we have long been conscious of. We continue to seek better covenant protection on those issues that we buy which can limit downside in such scenarios. For example a “change of control” clause can see us getting our money back immediately in the event of a leveraged takeover. Given the current market environment it’s definitely worth doing some legal homework in advance of buying a bond issued by an LBO target candidate.