Kmart real-estate-backed bonds higher on merger news; Gaylord upsizes 10-year deal

By Paul Deckelman and Paul A. Harris

New York, Nov. 17 - The news that Kmart Holdings Corp. and Sears Roebuck & Co. plan to merge in a nearly $11 billion, mostly stock transaction, sent the Troy Mich.-based discount retailer's real-estate secured notes several points higher, albeit in light trading.

The huge deal was the focus of conversation in an otherwise fairly quiet high-yield market. A related topic of conversation was whether the merger plans will be pushing Sears' currently investment-grade rated bonds into junk bond territory.

The primary market's mid-week session passed at a comparatively slow pace, in contrast to the Monday and Tuesday sessions which saw $2.8 billion of junk bonds that sold in 11 tranches.

Only Nashville, Tenn. lodging and entertainment firm Gaylord Entertainment Co. sold high-yield notes on Wednesday, in an upsized $225 million issue that priced on top of talk.

Elsewhere on the primary side, Syracuse, N.Y.-based fast food franchisee Carrols Corp. was heard getting ready to serve up a new bond deal right after Thanksgiving, with proceeds to be used to pay company shareholders a dividend.

Buy-side's quest for paper goes on

With over $5 billion of junk having priced last week, and the present week expected to top $7 billion, Prospect News enquired of Louise Rieke, portfolio manager of the Waddell & Reed Advisors High Income Fund, whether the new issue market is finally turning out enough bonds to meet the requirements of the buy-side.

Rieke responded in the negative.

"All of the supply is not registering much of an impact," she said.

"A couple of weeks ago when the market had a lot of calendar, the mutual funds were actually selling things to buy new issues. That would tell you that the mutual funds didn't have cash then.

"We have had a couple of coupon payments since then, so maybe they have a little more cash. But the money must be coming from the insurance companies and pension funds, where the really big cash balances must be."

Tightening still possible

Rieke also said that investor focus continues to remain fixed on the new issue market.

"I still think our market is very rich," she said. "Treasuries have traded off and we just keep grinding tighter and tighter.

"Everybody is trying to find stuff to buy. And everybody is focusing on the new issue market because there is hardly anything that you can buy in the secondary that has any value at all.

"According to JP Morgan's index, for the month of November so far we have tightened by 36 basis points," she added.

"There is a little room left, but you really have to scrounge for it.

"The spread to worst on the [JP Morgan] index is 369," Rieke continued. "Historically it has been tighter than that. So I guess it could get tighter. But it is going to have to come from the lower tiers.

"There is room to tighten, but the upside is not going to be as powerful as it has been.

"And whether it comes from us just holding still or Treasuries trading off - which is entirely likely - is hard to say."

Gaylord upsizes by $25 million

The only issue to price during the Wednesday session came from Gaylord Entertainment which priced an upsized $225 million issue of 10-year senior notes (B3/B) at par to yield 6¾%, on top of the 6¾% area price talk. The deal was increased from $200 million.

Louis Rieke said that the deal had initially been pro-formaed in the 6¾% to 7% range, so the yield had come in when official talk was released.

Deutsche Bank Securities and Banc of America Securities ran the books for the debt refinancing deal.

Additional add-ons

With the primary market "white hot," as one sell-side source characterized it on Wednesday, four issuers have stepped forward so far this week to tap their existing bonds with add-ons.

Smithfield Foods priced a $200 million add-on to its 7% senior notes due 2011 (Ba2/BB) at 106 on Monday, resulting in a 5.901% yield to worst. And Pinnacle Entertainment, Inc. is expected to price a $100 million add-on to its 8¼% senior subordinated notes due 2012 on Thursday.

Two more issuers stepped forward with add-on deals on Wednesday.

Eschelon Operating Co. began a brief roadshow for a $65 million add-on to its 8 3/8% senior secured second priority notes due March 15, 2010 (existing ratings Caa1/CCC+), with pricing expected on Friday via Jefferies & Co.

The Minneapolis-based voice, data and internet services provider will use the cash to fund an acquisition, repurchase convertible preferred shares and for general corporate purposes.

Elsewhere a conference call is set to take place at 11 a.m. ET on Thursday for Broder Brothers Co.'s $50 million add-on to its 11¼% senior notes due Oct. 15, 2010 (B3/B-), with pricing expected to follow on Thursday afternoon.

UBS Investment Bank has the books for the debt refinancing deal from the Plymouth, Mich.-based distributor of imprintable sportswear and accessories.

Stena talk, Rogers guidance

Price talk of 7% to 7¼% emerged Wednesday on Stena AB's $200 million of 12-year non-call-five senior notes (expected ratings Ba3/BB-), with pricing expected to take place Thursday afternoon via JP Morgan and Citigroup.

Meanwhile guidance levels were heard Wednesday on the massive issuance expected to price this week from Rogers Wireless Communications Inc.

Rogers Wireless, Inc. is in the market with approximately $2.350 billion in five tranches - four in U.S. dollars and one in Canadian dollars.

Guidance on those tranches was heard as follows:

* Low-to-mid 7% range on the U.S. dollar eight-year senior secured fixed-rate bullet (Ba3/BB/BB+);

* 25 basis points behind the eight-year bond on the U.S. dollar 10-year senior secured fixed-rate bullet (Ba3/BB/BB+);

* 50 basis points behind the eight-year bond on the Canadian dollar seven-year senior-secured fixed-rate bullet (Ba3/BB/BB+);

* 100 basis points behind the eight-year bond on the U.S. dollar eight-year non-call-four fixed-rate senior subordinated note (B2//BB-); and

* Libor plus 325-350 basis points on the U.S. dollar six-year non-call-two senior secured floating-rate note (Ba3/BB/BB+)

Guidance was also heard on Rogers Cable Inc.'s $425 million of senior secured second priority notes (Ba3/BB+):

* The high 6% range for the U.S. dollar 10-year bullet; and

* 25 basis points behind the 10-year bond on the Canadian dollar seven-year bullet.

Official price talk is expected to surface on Thursday, with pricing anticipated to take place Friday.

Louise Rieke told Prospect News that her fund is having a look at the Rogers deals.

New homebuilders weak

There was not much trading seen in recent new deals, although the new offerings brought earlier in the week by homebuilders William Lyons Homes and Hovnanian Enterprises were heard to have traded off.

A buyside source said of Hovnanian's new 6% notes due 2010 and 6¼% notes due 2015, which had both priced at par on Monday, along with William Lyons' 7 5/8% notes due 2012, that "they were priced so tight. If you have a low-six or five-handle right now, it's just going to sit there. It's not going to have much of a bounce to it because the coupon is so low, and it's tied to Treasuries."

Kmart higher

Back among the established issues, the Kmart paper was "bid up two or three points in very light trading," a trader said, although he didn't know why, since different tranches of the bonds are secured by different properties owned by Kmart, so the impact of its planned merger with Sears would be difficult to judge on any one particular security (see related article elsewhere in this issue).

He quoted Kmart's D-R structured StarFin 6.66% notes better at 83.5 bid, while the StarFin 7.43% notes were at 83, and its 9.35% notes due 29014 were at 86.

By way of contrast, Kmart's secured 8.54% notes due 2015 continued to languish around 37 bid, although its 9.44% notes due 2018 had firmed to 84 bid, 85 offered and its 8.80% notes due 2010 were at 88 bid, but only "a very small " piece had traded at that level.

Indeed, the market for Kmart secured notes - which earlier in the year had shot up rapidly as Kmart made deals with retailers including Sears and The Home Depot to sell properties that it no longer wanted - was "very light," the trader said, "mostly on no supply.

"A lot [of the secured Kmart paper] is self-liquidating," he explained, being taken out after the debt securing it was paid down or paid off from real estate proceeds.

During the conference call held by Kmart chairman Edward Lampert and other Kmart and Sears executives involved in the merger, the question came up about Kmart's liquidation of unwanted properties.

Lampert has recently been compared to legendary investment guru Warren Buffet, who was wildly successful in taking a failed textile company, Berkshire Hathaway, getting it out of the textile business and making the company a general investment vehicle in areas far removed from its original textiles. By the same token, it has been speculated that Lampert took control of Kmart while it was reorganizing in order to be able to reap the gains from the liquidation of its extensive portfolio of real estate holdings.

However, during the conference call, Lampert said: "I don't think any retailer should aspire to have real estate worth more than operating the business."

While he said there might be some further monetization of Kmart real estate, as circumstances warranted, the game plan would be mostly geared toward converting some Kmart stores over to Sears, while continuing to operating the rest as usual.

Kmart has no other bonds out, its former high-yield unsecured bonds having been retired when the company reorganized.

Sears, on the other hand, does have some investment-grade rated bonds out - and while the company's shares gained smartly on the merger news, the 7% percent bonds due 2032 were seen to have widened out by at least 26 basis points from where they had been earlier in the week, pre-news, to about 215 bps over Treasuries.

Sears bondholders were jolted by Moody's Investors' service having downgraded its bonds to Baa2 from Baa1, and said that it might drop it another notch - which would keep the bonds barely investment grade, at Baa3 - or perhaps two notches, which would drop the bonds into junk territory.

Standard & Poor's meantime kept Sears' corporate credit at BBB, though on review for a possible downgrade. And it said that it expected to give the Sears-Kmart combo a rating in the BB area.

S&P warned that "despite the (merged) company's much greater size, and synergies that are estimated by management of about $500 million per year after the third year, both companies lag their peers," such as Wal-Mart and Target for Kmart and J.C. Penney for Seas, "in terms of store productivity and profitability."

The ratings agency further cautioned that "business risk for the combined entity will limit consideration for an investment-grade rating."

Levi Strauss higher

Elsewhere, a trader said that Levi Strauss & Co. paper was "pretty strong," citing renewed rumors that the San Francisco-based apparel company - which recently called off plans to sell its profitable Dockers casual clothing unit after months of market belief that it would sell it - might again consider asset sales. He saw Levi's 7% notes due 2006 firm to 99.5 bid, on the rumor that "they're going to take those out" with any such proceeds.

Levi's 11 5/8% notes due 2008 closed at 104.5 bid and its 12¼% notes due 2012 at 105.25 bid, 105.375 offered.

A market source at another desk however, saw the bonds unchanged at slightly lower levels than that.

He did see Primus Telecommunications' 12¾% notes due 2009 four points better on the session, at 93, but said there was no news out on the company.

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