Clariant Bonds Could Offer Hefty Rewards to Investors
By DAVID REILLY
Staff Reporter of THE WALL STREET JOURNAL
Clariant AG shares took another drubbing last week as fears continued to
mount that the world's second-largest specialty-chemicals company may have
to turn to markets for funds to repair its balance sheet.
Although worries about a potential rights issue have plagued the stock
since the beginning of the year, they gained new life after the Swiss
company two weeks ago announced it was halting its biggest investment
project, a plant in the U.S. that was supposed to supply Procter & Gamble
Co., and that it would take a write-down of 120 million Swiss francs
($88.8 million or ?77.8 million) as a result.
Clariant's stock fell nearly 9% last week even though the company has
denied that it has any plans to tap the equity markets this year. The
shares, which are down nearly 45% since the start of the year, edged up 10
Swiss centimes Friday to 12.55 francs in Zurich.
Capital-increase rumors aside, the stock is likely to stay under pressure
for some time given the challenging business conditions facing Clariant
and the specialty-chemicals industry as a whole, along with the company's
need to restructure after overpaying for acquisitions in recent years. In
addition, analysts have been ratcheting down earnings expectations during
the past two weeks and lowering recommendations on the stock. In a note to
investors after Clariant's announcement about the U.S. plant, J.P. Morgan
cautioned that there is still a lack of transparency on Clariant's
forecasts, strategic direction and its ability to meet its goal of
reducing net debt to 2.5 billion francs by the end of this year from a
current level of about 3.5 billion francs.
Despite the gloom, some bond investors think there is an opportunity to be
had here. They believe that concerns about a cash crunch are overdone
because the company should be able to sell assets as planned and that with
a new chief executive at the helm, a turnaround may be in the offing.
If that's the case, Clariant's debt, unlike its stock, could offer some
hefty rewards. While corporate-bond spreads -- the difference between the
yield on a bond and the yield on offer from risk-free, benchmark debt --
have narrowed significantly in recent months, Clariant's debt continues to
trade at a distressed level. This reflects the worries surrounding risks
to its businesses from rising raw-material prices, falling demand and
negative effects from a strong euro.
In addition, Clariant's debt is 3.8 times its equity, which has been
falling because of repeated write-downs, and a further decline in earnings
this year could put the company in breach of covenants on its banking
facilities. If that were to happen, the company would be pushed into a
funding crisis and both the stocks and the bonds could get pounded
further. Clariant had to renegotiate terms of its bank debt at the end of
last year and could be forced to do the same this year, pushing up its
interest costs.
But bond bulls are betting the company will be able to avoid breaching
covenants and will somehow raise funds. Unlike those holding the company's
stock, bondholders don't care if the money comes from asset sales, a
rights issue or a sale of new debt. In any case, an injection of additional
funds would alleviate fears about the balance sheet, presumably causing the
yield on Clariant's bonds to fall and the price of the debt to rise in
value.
They also believe that the company could assuage fears of a cash crunch
even if it sells only a portion of the assets it wants to put on the
block. They expect the company to be able to finance a large portion of the
432 million francs in long-term debt coming due this year with cash
generated from operations. A spokesman for Clariant said the company
expects to finance all the redemptions this year with the cash it
generates; the company also expects to roll over about 660 million francs
in short-term debt that comes due.
Even if Clariant falls short of generating enough cash to cover the 432
million francs coming due, asset sales might be able to cover the
remainder. A similar scenario should unfold next year, when the company has
about 490 million francs of long-term debt coming due. Things get tougher
in 2005 when 700 million francs in debt comes due, but the company should
have enough time to sell off businesses and restructure before that
deadline looms, the bulls argue.
In looking to realize a windfall from Clariant's debt, investors are
hoping for a replay of what happened this year at French
specialty-chemicals company Rhodia SA. Late last year the spreads on that
company's bonds widened to distressed levels in anticipation of its debt
being downgraded from investment-grade to junk status, which happened
early in 2003. Although the markets appeared closed to the company, which
was reliant on short-term funding and so needed to be able to tap markets
quickly, some investors figured the company would be able to restructure
its debts. Rhodia did this successfully in May when it launched a ?1
billion ($1.14 billion) high-yield offering and used the proceeds to
retire short-term bank debt. The spreads on Rhodia's other debt then
narrowed dramatically.
Banking on such a turnaround at Clariant isn't without risk, of course.
First, the bonds aren't very liquid and trade infrequently. Clariant has
only about ?825 million in Swiss-franc-denominated debt, and the spokesman
said the company has no plans at the moment to try to tap the high-yield
or convertible-bond markets. Also, new CEO Ronald Loesser, who was
appointed in March to replace Reinhardt Handte, needs to come up with a
credible restructuring strategy when he meets with investors for the first
time in early August upon the release of first-half results. Without a
plan that garners confidence or a clear sign that the company has secured
additional funding, the debt isn't likely to take off.
Finally, operating margins at the company's businesses could continue to
come under pressure, cash generation could fall, and failure to meet the
debt-reduction goal could sorely try investors' patience.
Write to David Reilly at david.reilly@wsj.com
Updated June 30, 2003 |
