Covenant Review: Kraft, subsidiaries' debt should stay with global snacks unit in company split

By Andrea Heisinger

New York, Aug. 5 - Kraft Foods Inc. announced that it would split into two publicly traded companies, and analysts at Covenant Review, an independent research firm, think the company's debt should go to one entity over the other.

There are several outstanding bonds under Kraft, including its own, those of Nabisco and Cadbury plc and subsidiaries, which the company acquired when it bought those companies.

Kraft announced in a press release on Thursday that it would split into two parts comprising its global snacks and North American grocery businesses. The North American grocery business will be a tax-free spin-off for shareholders.

"We have built two strong, but distinct, portfolios," said Kraft chair and chief executive officer Irene Rosenfeld in a press release.

"The global snacks business has tremendous opportunities for growth as consumer demand for snacks increases around the world. The North American grocery business has a remarkable set of iconic brands, industry-leading margins, and the clear ability to generate significant cash flow."

The Kraft bonds have a mergers covenant that says they must travel with assets that are transferred, and Cadbury's bonds due 2013 have the same provision, according to the Covenant Review report.

Due to this provision, analysts said in the report that the "most logical approach for the company would be to spin off the [North American] grocery business, leaving the global snacks business as the 'company' under the bonds."

Analyst Alexander G. Diaz-Matos said in an interview with Prospect News that there was a "spectrum of responses from bondholders" over news of the split, and that their clients had a "range of responses."

"I think they were concerned about the downside protection," Diaz-Matos added. "There was concern about the amount of leverage."

If the company decides to spin off North American grocery into a new entity and the bonds remain at Kraft, then the global snacks side of the business would have higher leverage, according to the report. Between $5 billion and $6 billion of the company's $27 billion worth of debt will come off prior to the split, Diaz-Matos said. This is due to near-term maturities prior to the spin-off.

If too much leverage remained, then Kraft or the global snacks business could propose an exchange offer to maintain its investment-grade rating, allowing bondholders to swap some Kraft bonds into the North American grocery spin-off bonds, according to the report.

"Bondholders prefer to be with the global snacks because it's the larger of the two," Diaz-Matos said in an interview. He added that bondholders would be more upset if the global snacks was spun off and the North American grocery segment was left as the main business where the bonds were held.

While the number of outstanding bonds under Kraft won't complicate the split, what will is how to maintain investment-grade credit ratings after the split, Diaz-Matos said.

Covenant Review's report also touches on the fact that Kraft and Cadbury notes don't have downside protection via a 101% change-of-control put in the event of the company breaking up.

The change-of-control triggering event that some of the euro-denominated bonds have includes the company going below investment-grade ratings.

"There would be no put right for bondholders in such a spin-off," according to the report. The grocery spin-off could not constitute a transfer of substantially all assets as also required in a change-of-control event. Even if the split went the other way and the global snacks unit was spun off, there would still be no put right.

All three credit ratings agencies affirmed Kraft Foods and subsidiaries' credit ratings on Thursday. Moody's Investors Service kept its rating at Baa2, Standard & Poor's at BBB with a cut from positive to stable, and Fitch Ratings listed it as unchanged at BBB-.

Kraft Foods is a convenience food company based in Northfield, Ill.

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