- Change-of-control clause requires at least two cuts to junk
- While unlikely, holders avoid `worst-case scenario' in merger
Johnson Controls Inc.’s $28.7 billion acquisition of Tyco International Inc. is posing a dilemma for the target’s bondholders: they can only demand early repayment if the deal results in two or more ratings firms downgrading the company’s bonds to junk, according to Covenant Review.
That change-of-control clause doesn’t seem likely to be triggered, said Alex Diaz-Matos, an analyst at Covenant Review, who added that it might not be a bad thing for Tyco debt investors.
"Tyco bondholders are avoiding a worst-case scenario" like a leveraged buyout, he said. "And they’ll be lenders to a much larger company -- maybe that’ll be a benefit to them."
Johnson Controls and Tyco said Monday they agreed to a deal that would combine their building-control businesses in a Cork, Ireland-based company.
Tyco’s bonds have an A3 rating from Moody’s Investors Service, four levels above junk, and a BBB+ grade from Standard & Poor’s, one notch lower. The combined company said it is committed to retaining a strong investment-grade balance sheet. Johnson Controls is also rated investment grade, Baa2 by Moody’s and BBB+ by S&P.
Moody’s said Monday it may downgrade some of Tyco’s bonds depending on how the acquisition affects earnings, cash flow, structure and financial policies. It also said it could upgrade Johnson if the combination brings the promised "strategic opportunities.” S&P said it could also cut its credit rating on the company because leverage metrics will probably deteriorate as a result of the deal.
The transaction is expected to create at least $150 million in annual tax savings, the company said. Tyco, a former U.S. conglomerate that divided into multiple companies after former Chief Executive Officer Dennis Kozlowski was forced out in 2002 and later went to prison, has been domiciled in Ireland since 2014, with prior stops in Switzerland and Bermuda.
The companies project the deal will result in at least $650 million in total savings, which they said would be achieved over three years.
The deal may yet present dangers for holders of the debt of either company, according to Bloomberg Intelligence’s Joel Levington. Tyco could see its A tier ratings "negatively affected," given Johnson’s lower credit rating. Spreads on the bonds could also widen, he said.
Yields on Tyco’s bonds could continue to widen versus benchmarks, and will probably end up trading at spreads that are more similar to the premium on bonds of lower-rated Johnson Controls, CreditSights Inc. analysts led by Kristina Regan wrote Monday.
The bonds could also underperform because debt for the $3.9 billion cash consideration of the acquisition will be raised at the Tyco level before the merger, Regan said. Tyco has secured a committed $4.0 billion bank facility to finance the cash consideration of the transaction.
Prices on some of Tyco’s bonds rebounded Tuesday after declining Monday. Its $750 million of 5.125 percent notes that mature in 2045 yielded 5.03 percent at the 10:44 p.m. price of 101.469, which is up 0.34 cents on the day. It fell 4.97 cents Monday.