THE GREAT WEALTH TRANSFER

Isle of Capri announced today a tender offer to buy back up to $140 million of its bonds at 58 cents on the dollar. This transaction allows ISLE to deleverage by the amount of the discount, adjusted for taxes. In this case, ISLE spends only $140 million to retire $241 million worth of bonds. The current tax regulations force ISLE to pay tax on the differential at the company’s ordinary tax rate so the net effect is 35-40% less but still material.

Other companies that have the ability to follow this strategy include MGM and BYD. Both companies maintain ample availability on their credit facilities but face covenant issues. Clearly, buying discounted bonds should be a major deleveraging maneuver that both should pursue. Their bonds are more liquid so hopefully bond buybacks are already underway for each company. MGM appears to be willing to compound the positive impact by selling off assets and potentially using the proceeds to buy more bonds. Importantly, MGM’s credit facility does not restrict it in this area.

The following example details the math behind the strategy. Assuming a company with $200mm in EBITDA and an enterprise value of $1.4bn tenders for $200mm face value of bonds and pays 10 cents on the dollar above the market price of 50 cents, $51mm of equity value is potentially created.

Of course, a stock is a discounting mechanism so some of the potential may already be factored in. However, we don’t think many equity investors understand the power of these transactions, particularly for a company like MGM where sentiment is wildly negative surrounding covenants, liquidity, and its balance sheet. MGM equity holders probably have the most to gain with a corporate bond buyback strategy.


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