HBI followed up on its announcement 2.5 weeks ago of starting the process to amend its credit facility before year end.
Friday the company announced its new credit agreement.
The details include:
-increased capacity of $300mm to $2.25bn
-lower rates on its revolver and term loans, (interest impact will depend on leverage rate)
-increased leverage ratio limit to 4.5x/5.0x Net Debt to EBITDA vs prior 4.0x/4.5x (ratio increases to higher limit for quarters ending in the 12month period following the closing of a $200mm+ acquisition)
Our sense is that the amendment means 1 of 3 things:
- The company needs it for a deal to perpetuate the game of buy growth/cash flow and charge-off expenses for 3-4 years.
- Business is awful and HBI needs the higher roof while the market allows it to avoid covenant limits.
- With tax reform likely to drive HBI's tax rate up by 2-3x, it simply needs the higher leverage ceiling to avoid a covenant bust while managing working capital.
Due to timing it would seem number 3 is the most likely scenario, since the original announcement came right around the time the Senate was near passing its version of the tax reform bill.
The conference committee version of the tax bill includes mandatory repatriation of indefinitely deferred foreign earnings, of which HBI holds $3.3bn.
The math on the impact is below, assuming HBI is liable for 100% of its indefinitely deferred foreign earnings. There could end up being some credits/deductions applied later. The math looks solely at repatriation and does not include the (small) benefit from a lower US corporate rate, and the (big?) negative impact of now being taxed on a portion of earnings in tax haven subsidiaries.
Number 2 and number 1 above both seem less likely, but plausible rationales for the amendment. HBI does have the acquisition of Alternative Apparel in 4Q with a $60mm price tag. Perhaps 4Q performance meant the company would have been near the 4.0x leverage limit.
Amending the agreement to achieve lower rates makes sense and is likely a positive on the margin for equity holders. However, we're not sure more leverage room and higher borrowing capacity is a positive for shareholder returns with a management team that has recently paid questionable prices for below average assets in the basic apparel industry.
After all, if management can execute on its guidance and plan to get to $1bn in CFFO by 2019, this stock is headed higher. So why introduce more debt, and operational distractions (new deals) if the project booster path to $1bn is clearly laid out.
Our view is that more debt, and more deals, will ultimately lead to greater destruction of shareholder value in the long term.
