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Primary Analysis: Johnson Controls Plans Documents Amendments After Investors Flag Aggressive Terms; Buysiders Praise Business Resilience, Consider Impact of Lithium-ion Battery Technology
Wed 03/13/2019 11:45 AM
Relevant Document:
Offering Memorandum
The arrangers on Johnson Controls Power Solutions’ $4.7 billion secured and unsecured notes are working to amend the bond covenants after investors expressed concerns about terms allowing the company to make large transfers of cash away from creditors. Though no official pricing guidance has been issued, investors expect the amendments may lead to lower pricing of the notes, sources told Reorg.
The bond package includes $2 billion seven-year senior secured notes, $750 million euro-equivalent seven-year senior secured notes and $1.95 billion eight-year senior unsecured notes. The secured bonds are rated Ba3/B+/BB while the unsecureds are at B3/B/B-. Reorg Debt Explained reviewed the bond covenant package HERE and did a comparative analysis of the financing to that of Refinitiv HERE.
Initial whispers on the $2 billion seven-year senior secured notes were in the low 7% to 6.75% area. For the $750 million euro-equivalent seven-year senior secured notes, initial whispers were in the low 5% area and the high 4%. On the $1.95 billion eight-year unsecured notes, whispers were in the low 9% area.
Some investors looking at the euro tranche of the bond offering noted that price whispers of low 5% to high 4% were wider than where most double-B rated notes have been since the start of the year, offering a pick-up in yield. This, coupled with a relative scarcity of deals in the market, is drawing investors to the deal despite opening leverage of 6.1x.
Credits rated in the double-B area such as U.S. data manager Equinix, Faurecia and German real estate firm Corestate priced six- and seven-year issues with initial yields at high 2% and low 3% during the first quarter last year.
There are no obvious comparables for the company, some analysts noted, as many double- and single-B rated auto parts manufacturers are primarily focused on producing parts for new vehicles rather than serving aftermarket retailers.
A possible comparable is U.S.-based spare parts provider Ba2 and BB-rated LKQ, sources said. LKQ has a €750 million bond with a 3.625% coupon maturing in 2026, yielding 3.3%. In its dollar-denominated debt it also has a $600 million bond with a 4.75% coupon yielding about 4.55%. Investors also mentioned American Axle which has Ba2-rated secured debt and B2 rated unsecured notes, as a comparable. They have also referred to Garrett Motion which issued a euro-denominated 2026 bond paying 5.125% rated B2/B last year.
Another potential comparable is French autoparts company Autodis, whose recent issue carried a B3/B rating. Autodis’ €175 million floating rate note was priced at Euribor+ 550 basis points with an OID at 99.25 on Jan. 30. Autodis’ lower rating and a different business model make the comparison less straightforward.
Under Johnson Controls Power Solutions bond documentation the company is permitted to transfer assets up to an amount corresponding to 215% of its EBITDA. This compares to 140% for last year’s Refinitiv deal, and 138% for Envision Healthcare, both of which were considered to be setting a new standard of aggressive documentation.
Investors have expressed concern about the deal’s permissive covenants and the fact that the RP buildup basket, which determines the amounts available to be paid out as dividends, allows a significant starter basket equal to the greater of either $700 million and 42.5% of LTM EBITDA. In addition, any amounts declined by noteholders in an asset sale offer are also permitted to be added back to the RP build up thereby increasing amounts available for dividend payouts.
The corporate structure is below:
Earnings Resilience
Analysts were reassured by the fact that the company is only 25% exposed to the market for new vehicle parts (the Original Equipment Manufacturer market), with the remainder of its business focused on spare parts for existing vehicles, making the group more resilient during an economic downturn.
Despite the aggressive bond terms, investors have noted that Johnson Controls Power Solutions business has recorded 9% revenue growth to $8 billion in its financial year ending Sept. 30, 2018. This followed a 10.3% growth in the year ended Sept. 30, 2017. Revenue has since continued to rise coming in at $8.297 billion in the 12 months to Dec. 31, 2018.
Since 2016, the group has generated EBITDA margins in the low 20%. However, margins have eroded from 23% to 20.1% since 2016 based on relatively flat EBITDA against growing sales.
Based on cash from operations of $959 million on a last-12-months’ basis and capex of $348 million, the business recorded free cash of $611 million basis in the year to Dec. 31, 2018.
As the group has pro forma net debt of $10.15 billion, the deal comes with net leverage of 6.1x. As a result, if the business fails to maintain its current level of EBITDA generation, net leverage could quickly jump to unsustainable levels.
The company’s capital structure is below:
Some analysts pointed to uncertainty regarding the role that the lead-acid battery, which is the primary focus of the company’s business, will play in the automotive sector as vehicles become increasingly electric.
The bond offering memorandum states that, as vehicle manufacturers continue to shift their focus toward electrification, the lead-acid battery will become an increasingly important passenger safety feature in electric vehicles. Lead-acid batteries control the traction battery in electric vehicles, protecting passengers in the event of traction battery failure, a function which the offering memorandum says cannot be effectively replicated using current lithium-ion battery technology.
The OM acknowledges the negative impact of potential increases in lithium-ion battery volumes on established lead-acid battery volumes as lithium-ion battery technology grows and costs become more competitive.
Roadshows for the secured and unsecured notes will continue until March 14, with pricing expected on March 15.
Financing Details
Proceeds of the full debt are intended to finance the acquisition of the company by Canada’s Brookfield Asset Management for about $12.723 billion.
Use of proceeds is below:
Price talks on the seven-year $3.2 billion term loan B is at LIBOR+400-425 bps with a 0% floor and a 98.5 OID, while for the seven-year $2.25 billion euro-equivalent term loan B it is at Euribor+400-425 basis points with a 99 OID.
Price talk on the dollar-denominated term loan also seems above the average for recent double-B rated loans. This is likely intended to attract investors given the large supply of loans in the U.S. and the size of the deal, however the margin is likely to tighten before final allocation, investors said. Demand for the loan issue has already been strong, they said.
Lender commitments are due on March 14.
Offering Memorandum
The arrangers on Johnson Controls Power Solutions’ $4.7 billion secured and unsecured notes are working to amend the bond covenants after investors expressed concerns about terms allowing the company to make large transfers of cash away from creditors. Though no official pricing guidance has been issued, investors expect the amendments may lead to lower pricing of the notes, sources told Reorg.
The bond package includes $2 billion seven-year senior secured notes, $750 million euro-equivalent seven-year senior secured notes and $1.95 billion eight-year senior unsecured notes. The secured bonds are rated Ba3/B+/BB while the unsecureds are at B3/B/B-. Reorg Debt Explained reviewed the bond covenant package HERE and did a comparative analysis of the financing to that of Refinitiv HERE.
Initial whispers on the $2 billion seven-year senior secured notes were in the low 7% to 6.75% area. For the $750 million euro-equivalent seven-year senior secured notes, initial whispers were in the low 5% area and the high 4%. On the $1.95 billion eight-year unsecured notes, whispers were in the low 9% area.
Some investors looking at the euro tranche of the bond offering noted that price whispers of low 5% to high 4% were wider than where most double-B rated notes have been since the start of the year, offering a pick-up in yield. This, coupled with a relative scarcity of deals in the market, is drawing investors to the deal despite opening leverage of 6.1x.
Credits rated in the double-B area such as U.S. data manager Equinix, Faurecia and German real estate firm Corestate priced six- and seven-year issues with initial yields at high 2% and low 3% during the first quarter last year.
There are no obvious comparables for the company, some analysts noted, as many double- and single-B rated auto parts manufacturers are primarily focused on producing parts for new vehicles rather than serving aftermarket retailers.
A possible comparable is U.S.-based spare parts provider Ba2 and BB-rated LKQ, sources said. LKQ has a €750 million bond with a 3.625% coupon maturing in 2026, yielding 3.3%. In its dollar-denominated debt it also has a $600 million bond with a 4.75% coupon yielding about 4.55%. Investors also mentioned American Axle which has Ba2-rated secured debt and B2 rated unsecured notes, as a comparable. They have also referred to Garrett Motion which issued a euro-denominated 2026 bond paying 5.125% rated B2/B last year.
Another potential comparable is French autoparts company Autodis, whose recent issue carried a B3/B rating. Autodis’ €175 million floating rate note was priced at Euribor+ 550 basis points with an OID at 99.25 on Jan. 30. Autodis’ lower rating and a different business model make the comparison less straightforward.
Under Johnson Controls Power Solutions bond documentation the company is permitted to transfer assets up to an amount corresponding to 215% of its EBITDA. This compares to 140% for last year’s Refinitiv deal, and 138% for Envision Healthcare, both of which were considered to be setting a new standard of aggressive documentation.
Investors have expressed concern about the deal’s permissive covenants and the fact that the RP buildup basket, which determines the amounts available to be paid out as dividends, allows a significant starter basket equal to the greater of either $700 million and 42.5% of LTM EBITDA. In addition, any amounts declined by noteholders in an asset sale offer are also permitted to be added back to the RP build up thereby increasing amounts available for dividend payouts.
The corporate structure is below:
Earnings Resilience
Analysts were reassured by the fact that the company is only 25% exposed to the market for new vehicle parts (the Original Equipment Manufacturer market), with the remainder of its business focused on spare parts for existing vehicles, making the group more resilient during an economic downturn.
Despite the aggressive bond terms, investors have noted that Johnson Controls Power Solutions business has recorded 9% revenue growth to $8 billion in its financial year ending Sept. 30, 2018. This followed a 10.3% growth in the year ended Sept. 30, 2017. Revenue has since continued to rise coming in at $8.297 billion in the 12 months to Dec. 31, 2018.
Since 2016, the group has generated EBITDA margins in the low 20%. However, margins have eroded from 23% to 20.1% since 2016 based on relatively flat EBITDA against growing sales.
Based on cash from operations of $959 million on a last-12-months’ basis and capex of $348 million, the business recorded free cash of $611 million basis in the year to Dec. 31, 2018.
As the group has pro forma net debt of $10.15 billion, the deal comes with net leverage of 6.1x. As a result, if the business fails to maintain its current level of EBITDA generation, net leverage could quickly jump to unsustainable levels.
The company’s capital structure is below:
Some analysts pointed to uncertainty regarding the role that the lead-acid battery, which is the primary focus of the company’s business, will play in the automotive sector as vehicles become increasingly electric.
The bond offering memorandum states that, as vehicle manufacturers continue to shift their focus toward electrification, the lead-acid battery will become an increasingly important passenger safety feature in electric vehicles. Lead-acid batteries control the traction battery in electric vehicles, protecting passengers in the event of traction battery failure, a function which the offering memorandum says cannot be effectively replicated using current lithium-ion battery technology.
The OM acknowledges the negative impact of potential increases in lithium-ion battery volumes on established lead-acid battery volumes as lithium-ion battery technology grows and costs become more competitive.
Roadshows for the secured and unsecured notes will continue until March 14, with pricing expected on March 15.
Financing Details
Proceeds of the full debt are intended to finance the acquisition of the company by Canada’s Brookfield Asset Management for about $12.723 billion.
Use of proceeds is below:
Price talks on the seven-year $3.2 billion term loan B is at LIBOR+400-425 bps with a 0% floor and a 98.5 OID, while for the seven-year $2.25 billion euro-equivalent term loan B it is at Euribor+400-425 basis points with a 99 OID.
Price talk on the dollar-denominated term loan also seems above the average for recent double-B rated loans. This is likely intended to attract investors given the large supply of loans in the U.S. and the size of the deal, however the margin is likely to tighten before final allocation, investors said. Demand for the loan issue has already been strong, they said.
Lender commitments are due on March 14.
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