LIZ is taking a step towards reducing earnings volatility by announcing it will retire nearly half (€100mm) of its €221mm Eurobond exposure per an 8K filing that hit this morning. While the notes aren’t due until July 2013, this tranche is among the company’s highest priorities of debt to settle due to the volatile hedging associated with it that’s been accounted for in the Other Income line on the P&L. This is clearly a positive for the company. But what about the stock relative to investor expectations? Here are a few thoughts:
- The company is taking action (something we’re now growing accustomed to seeing) in order to reduce earnings volatility – positive.
- The Eurobonds pay interest on an annual basis so the accrued interest re this transaction will amount to nearly $3mm for a total payment of ~$135mm.
- Management stated as recently as its Q3 conference call (11/9) that it expects to 1) have $0mm drawn on its revolver, and 2) have enough cash to ultimately settle the Eurobond in full by year-end. This move adds some clarity as the company appears to have the cash now to settle the rest, but question remains how?
- The direct purchase of 45% of the outstanding Eurobonds from a single bond holder at reasonable rates is essentially a best case scenario. As for the balance, it can be retired a number of ways as outlined at LIZ’s Analyst Day back on April 28th(see below). Essentially, the company can make additional purchases directly, through the open market, or tender an offer.
- While direct or open market purchases would be most cost effective for shareholders, we think that the company will retire the rest its outstanding Eurobonds early in the 1H of next year.
- Keep in mind that until then, Fx rates are moving in the company’s favor. Take a look at the table below. Since the analyst day back in April, the strength of the US dollar has cut the USD/Euro rate to 1.32 from 1.48 effectively reducing the cost of the Eurobonds by more than 10%, or $35mm. Looking forward, every $0.05 swing in the USD/Euro exchange rate will account for another ~$6mm change in the balance of the company’s €121.5mm outstanding Eurobonds. At this rate, with the continued strength in the USD there's simply no rush.
All in, we think this move should be viewed positively as yet another step in LIZ's transformation in to a growth company as it sheds legacy debt concerns. We didn't expect the full retirement of the Eurobonds by year-end, but we do expect the company to remain committed to this goal near-term in order to fully reduce related hedging volatility.
(Slide #175 from 4/28 LIZ Analyst Day):