A Sobeys store in Calgary on June 13, 2013. Empire Co.’s $5.8-billion acquisition of Safeway's Canadian assets will give it a foothold in sought-after retail markets in Western Canada.Todd Korol/The Globe and Mail
Empire Co.'s bondholders have to be loving the rise in the company's stock.
Empire is getting ready to start the road show for the massive $1.5-billion stock offering the grocery company is planning to fund part of its purchase of Safeway Inc.'s Canadian assets for $5.8-billion in cash, a deal that just keeps getting better for the Nova Scotia company. Empire is buying the Safeway assets to give its Sobeys grocery subsidiary a much stronger presence in Western Canada.
Equity investors love the deal. Bond investors, not so much. The issue is the added debt that is being piled on to fund the transaction.
The steady rise in Empire's share price, which has vastly outpaced its grocery rivals in the month since the transaction was announced, gives Empire a nice choice. Empire can keep the offering size steady, and issue far less stock to raise the $1.5-billion. That will feed earnings per share. Or Empire can crank up the offering and look to cut the leverage, which has had some analysts talking about the potential for a ratings cut that would cost the company its investment grade status.
Prior to the announcement of the transaction last month, Empire stock was trading at about $69 a share, so Empire would have been expecting to have to sell something like 22.4 million shares at a price around $67 apiece to raise $1.5-billion.
By late June, analysts at Veritas Investment Research were assuming a $73 issue price, implying about 20.6 million shares. At that point, Veritas was expecting the transaction could add $1.45 a share to 2016 earnings.
Now, the stock is close to $80 as the Empire executive team starts to sell the merits of the stock to investors in preparation for the offering. If Empire can pull off the offering at $76 a share, it's only 19.7-million new shares, or about 4 per cent fewer. That cranks the accretion up to something more like $1.50, a serious number for a company that analysts expect to earn $6.80 a share in 2015.
The other option would be to raise a bit more money on the equity side to eliminate any risk to the investment grade rating that the company says it considers a priority. The plan had been to use 44 per cent debt and 56 per cent equity, with a bond issue and a term loan on the debt side of the balance sheet. The original deal metrics would push debt to cash flow to 4 times from 2.2 times, which would be stretching the limits of an investment grade rating, according to an RBC report at the time.
The result was the spreads on Empire bonds blew out. Empire Co.'s 7.16 per cent bonds due in 2018 went from trading at about 122 basis points of yield – more than a similar government of Canada bond – to a peak of 181 basis points over in the wake of the deal. But now the spread is back to 171 basis points.
Why not split the benefits of the tear in the share price with bondholders? Given the company's stated commitment to remaining investment grade, if the market is there, it would not be surprising to see an already huge equity offering increased, with bondholders the beneficiaries.
(Boyd Erman is a Globe and Mail Capital Markets Reporter & Streetwise Columnist.)
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