October 23, 2013 / 6:05 PM / 6 years ago

UPDATE 1-Safeway CDS reflects high risk of LBO

By Melissa Mott

NEW YORK, Oct 23 (IFR) - The cost of insuring Safeway Inc’s debt against default rose sharply on Wednesday on a report that buyout firms are exploring a deal for all or part of the supermarket chain.

Safeway’s five-year credit default swaps (CDS) widened as much as 54.5 basis points to 256bp, a six-month wide. During that time, the spread has ranged between 155bp and 230bp.

Reuters reported Tuesday that buyout firms including Cerberus Capital Management are interested in the business.

It could potentially shape up to be one of the largest leveraged buyouts since the financial crisis.

“It is all just speculation at the moment, but the high risk premium attached to Safeway - it was already trading with an implied rating of BB - indicates that the market sees it as a possible LBO candidate,” Markit’s Gavan Nolan said in a comment.

Safeway is rated Baa3, BBB and BBB- by Moody’s, S&P and Fitch respectively.

Safeway, the second-largest US mainstream grocery chain with a market value of over US$8 billion, is not running an auction currently but is aware of buyout interest and reviewing options with advisor Goldman Sachs.

An LBO offer typically widens a company’s CDS due to the potential that the buyout candidate will take on a significant amount of debt financing and sink into junk territory as a result of higher leverage.

A credit default swap will readjust higher to compensate for the higher risk of default.

Worries about Safeway sliding into high-yield have intensified in recent months, particularly after Moody’s changed its outlook in June to negative from stable.

That move came after Safeway said it would sell off its operations in Canada, which Moody’s said raised questions about the company’s ability to boost operating earnings.

Safeway’s bonds, most of which have change of control language that limits the downside risk for investors, fell on Wednesday. Change of control covenants allow for redemption in case of a takeover.

The 5.00% 2019s, which contain change of control language, declined two points to $104.25, but the senior unsecured 7.25% 2031s, that do not have change of control, plunged in price to $100.49 from Tuesday’s close of $107.75.

One swaps trader said any takeover could push Safeway’s CDS spreads out to test the November 2012 wides of 400bp.

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