IN THE MONEY: Rite Aid Covenants Not Such A Non-Issue27 Feb 15:54
By Michael Rapoport A Dow Jones Newswires Column
NEW YORK (Dow Jones)--Just seven weeks ago, Rite Aid Corp.'s (RAD) management
seemed mortally offended by any suggestion that they might be in danger of
violating one of the company's debt covenants. "We don't see it as an issue,"
Chief Executive Bob Miller said then.
How things can change once push comes to shove, eh?
Rite Aid announced Wednesday that, lo and behold, it had worked out an
amendment to its $1.9 billion credit facility that "resets" the covenants it
has to meet to stay in good graces with its lenders. The new levels "allow the
company more operating flexibility," Rite Aid said.
The aim was to allow the debt-burdened drugstore chain to issue another
$149.5 million worth of debt to fund its payment settling shareholder
litigation against the company. But Wednesday's news is another indication that
Rite Aid was skating pretty close to the edge in its compliance with the old
covenants, as this column suggested last month - and that the need to issue new
debt could have pushed it into violating the covenants if something hadn't been
done. The litigation was over accounting irregularities under former management
that caused Rite Aid to restate two years' worth of earnings.
Karen Rugen, a Rite Aid spokeswoman, said the company was in compliance with
all debt covenants as of the Dec. 1 end of its last quarter and expected to
remain in compliance, but the decision to issue the new debt changed matters.
She wouldn't speculate about whether Rite Aid would have remained in compliance
if the covenants hadn't been changed.
It's not hard to reconstruct what was probably Rite Aid's thinking, though.
Start with the terms of the class-action settlement, announced in 2000, under
which Rite Aid had the option of paying $149.5 million in any combination of
cash, common stock or short-term notes. (Another $45 millionin cash has
already been paid, funded by Rite Aid's insurance.)
But Rite Aid had only $94.3 million in cash on its most recent balance sheet.
And based on its recent stock price, the company would have had to issue about
57 million new shares to fund that $149.5 million payment with stock - a big
dilutive hit to the value of its existing shares. In other words, issuing new
debt was the only feasible option.
But there was a problem there, too: A debt covenant in Rite Aid's credit
line, under which it was required to have total debt of no more than 7.75 times
EBITDA (earnings before interest, taxes, depreciation and amortization) in the
fiscal year that ends this Saturday.
Do the math and you can see the problem. Rite Aid has indicated it expects
EBITDA of $140 million in the current quarter - an outlook it reaffirmed
Wednesday. Combined with the $363.3 million EBITDA for the first nine months of
its fiscal year, that would give it EBITDA of $503.3 million for the full
fiscal year. Multiply that $503.3 million by 7.75 and that means debt would
have to be no more than $3.9 billion at fiscal year's end - just a few days
away, remember - to stay in compliance under the old covenants.
But as of Dec. 1, Rite Aid had $3.96 billion in debt. Even without the new
debt, then, it appears that the company would either have to beat its own
EBITDA estimate or trim its debt a little to stay in compliance. In fact, by
this column's calculations, Rite Aid was just barely in compliance at the end
of the Dec. 1 quarter: Its debt then was 8.19 times annualized EBITDA, just
below the ceiling of 8.25 under the then-current covenants.
And once you tack on that added $149.5 million in debt - boosting Rite Aid's
total debt, and thus its debt-to-EBITDA ratio - the company's problem becomes
clear. Absent an EBITDA performance far above expectations or a big reduction
in existing debt - neither of which appeared to be in the cards - Rite Aid's
only option was to get its lenders to relax the covenants. Which is precisely
what it did.
Now, under the revised covenants, Rite Aid only has to limit its debt to 8.4
times EBITDA for the fiscal year now ending - providing more flexibility. In
fact, it appears the new covenants get even more relaxed over the next several
months: Where the old covenants called for Rite Aid to have a maximum
debt-to-EBITDA ratio of 7.75 in the 12 months ending in May, the new covenants
allow that ratio to be up to 9.5. For the 12 months ending in August: old
covenants 7.5, new covenants 10. Those more relaxed standards would allow Rite
Aid either to issue more debt or have lower EBITDA while remaining in
compliance.
That greater degree of flexibility certainly reduces the chances that Rite
Aid will trip a covenant any time soon. And, along with the reaffirmation of
the EBITDA forecast, that's what's driven Rite Aid stock up 17% in the wake of
the company's statement.
But, the stock's rise notwithstanding, Wednesday's developments aren't a
reason for investors to be happy. When a company insists that its covenants
pose it no problem, and then just weeks later has to revise its covenants to
allow for a little new debt, that's a company that is cutting things close.
And in these times, already so uncertain and filled with risk, that's something
that investors may not want to stand for.
-By Michael Rapoport, Dow Jones Newswires; 201-938-5976;
michael.rapoport@dowjones.com (END) DOW JONES NEWS 02-27-02 03:54 PM |
