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Recently, I wrote an article on Limited Brands' (LTD) new debt issuance and the possibility that part of the proceeds could be used to fund a special dividend.

While reading through the prospectus on the issue, the bifurcation between their more recent debt (I will refer to it as "new debt") and their older debt (I will refer to it as "legacy debt" as it was issued when the company was still investment grade) was striking. For a company whose debt/capitalization is now 75%, covenants can make a significant difference in terms of protection.

Let's explore this difference as further evidence that not all debt is created equal. (Note all information is from company filings, price and yield data comes from the Trace reporting system.)

First, it helps to have a look at their outstanding debt:

From the above chart you can visually see the bifurcation of the debt. Let's explore the differences between the deals in a little more detail.

First the "legacy" debt:

click to enlarge

Covenants:

Change of control - Upon the occurrence of both (i) a change of control of Limited Brands and (ii) a downgrade of the notes below an investment grade rating by both Moody's Investors Service, Inc. and Standard & Poor's Ratings Services within a specified period, Limited Brands will be required to make an offer to purchase the notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase.

Limitation on liens - The company will not allow any subsidiary to secure any debt if such indebtedness is secured by a pledge of, lien on or security interest in any shares of Voting Stock of any Significant Subsidiary.

Limitation on merger or sale of assets - The company will not consolidate with or merge into another corporation, or sell other than for cash or lease all or substantially all their assets to another corporation, or purchase all or substantially all the assets of another corporation, unless either LTD or the successor company assumes the debt securities and there is no event of default.

Now the "new" debt:

Covenants/Provisions:

Guarantees - The notes will be guaranteed on an unsecured senior basis by each of the subsidiaries that guarantee the senior secured revolving facility.

Some information on the guarantors:

The guarantors represent (i) substantially all of the revenue of the company's domestic subsidiaries, (ii) more than 90% of the assets owned by their domestic subsidiaries, other than real property, aircraft and intercompany investments and (III) more than 95% of the accounts receivable and inventory directly owned by the domestic subsidiaries.

The Notes will be guaranteed, on a joint and several senior unsecured basis by each of the Domestic Subsidiaries that is a guarantor of their Senior Credit Facility.

Further:

If, after the issue date, any of their Domestic Subsidiaries becomes a borrower or guarantor under the Senior Credit Facility, then the company will be required to cause such domestic subsidiary to unconditionally guarantee all of the obligations under the notes and the indenture

35% Equity claw back -

  • 2019 notes: From time to time before June 15, 2012, the company may redeem up to 35% of the notes at a price 0f 108.5% with the net cash proceeds raised in one or more qualified equity offerings, so long as at least 65% of the original aggregate principal amount of the notes remains outstanding afterwards.
  • 2020 notes: From time to time before May 1, 2013, the company may redeem up to 35% of the notes at 107% with the net cash proceeds raised in one or more qualified equity offerings, so long as at least 65% of the original aggregate principal amount of the notes remains outstanding afterwards
  • 2021 notes: From time to time before April 1, 2014, the company may redeem up to 35% of the notes at a redemption price equal to 106.625% with the net cash proceeds raised in one or more qualified equity offerings, so long as at least 65% of the notes remains outstanding afterwards.
  • 2022 notes: Prior to February 15, 2015 the company may redeem up to 35% of the notes at a redemption price equal to 105.625% with the net proceeds of one or more qualified equity offerings, so long as at least 65% of the notes remains outstanding.

Change of control - If the company experiences a "change of control triggering event," they will be required to make an offer to purchase the notes at a purchase price of 101% plus accrued and unpaid interest to the purchase date. NOTE: This is the same as some of the "legacy" note CoC language - a change of control and below investment grade.

Limitation on liens - The company will not allow any subsidiary to secure any debt if such indebtedness is secured by a pledge of, lien on or security interest in any shares of Voting Stock of any significant subsidiary. NOTE: this is the same as the "legacy" debt.

Limitation on merger or sale of assets - The company will not consolidate with or merge into another corporation, or sell other than for cash or lease all or substantially all our assets to another corporation, or purchase all or substantially all the assets of another corporation, unless either LTD or the sucessor company assumes the debt securities and there is no event of default. NOTE: this is the same as the "legacy" debt.

Conclusion: There are significant differences in the terms of "legacy" debt and "new" debt that, given the yield on the entire debt complex, does not seem to be appreciated by the market and/or factored into the pricing of the various issues. The rating agencies, by notching the debt between the guaranteed debt and the non-guaranteed debt, recognize the structural subordination of the "legacy" debt. One would think that there would be a noticeable pricing difference between the "legacy" debt and the "new" debt, but there does not appear to be.

As a result, if I were to get long the debt of Limited Brands, I would get long the "new" debt and avoid the "legacy" debt. If I were going to buy the "legacy" debt, I would stay very short duration - possibly the 12s. I am not saying that Limited Brands is spiralling towards insolvency - its numbers have been strong - but rather that the structural differences should be better appreciated and reflected in the price/yield of the complex.

Note: If anyone would like a link to the various prospectuses, drop me a note and I will provide it.

Source: Limited Brands: All Debt Is Not Created Equal