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Tops raises $275 million in sale of high-yield bonds

By David Robinson

 Taking advantage of the strong demand among investors for high-yield bonds, Tops Markets, has raised $275 million in a debt offering that refinances its borrowings.

The Amherst-based supermarket chain, which Morgan Stanley Private Equity acquired from Ahold NV in a $310 million deal in December 2007, is using the proceeds from the debt sale to refinance existing debt.

Kevin Darrington, Tops’ senior vice president and chief financial officer, said Thursday that the bond sale gives the company more financial flexibility because it replaces more restrictive bank borrowings and extends the maturity date of its debt by a year.

The deal also leaves Tops with slightly more borrowing capacity, which gives the chain more leeway to operate the 76-store chain and meet its goal of adding seven to 10 stores over the next five years, he said.

The company also is using more than a third of the proceeds to pay a $105 million dividend to its private- equity shareholders, according to Standard & Poors, a credit rating agency.

Darrington said the dividend allows Tops’ shareholders to recoup some of their investment in the company, without adding significantly more leverage to the firm’s finances.

“The dividend was nothing more than recapturing the value that was created by this company over the last 20 months,” he said.

Tops joins a parade of companies that have tapped into the high-yield bond market to refinance debt and, in some cases, return cash to shareholders, as borrowing costs have dropped to their lowest levels since the late spring of last year.

Average yields on speculative- grade bonds are back in the 10 percent range, which is less than half of the 20 percent-plus rates that the high-yield market commanded last December, when the financial markets were reeling and investors were seeking only the safest of investments, pushing yields on U. S. Treasuries to record lows.

In Tops’ case, the bond sale will not significantly change the company’s borrowing costs, Darrington said.

With the stock market rallying and investors more willing to take on risk, the high-yield market has rebounded even more strongly, opening the door for highly leveraged companies, like Tops, to access the capital markets again.

So, earlier this month Tops sold the $275 million in senior secured notes carrying a coupon rate of 10.13 percent and maturing in 2015.

Demand for the debt offering was strong enough to allow Tops, which operates supermarkets in Western New York and Pennsylvania, to increase the size of the offering by $25 million from its initial plan.

With credit markets improving, the private-equity firms that own companies like Tops have been taking advantage of provisions in their original financing agreements that let them raise more capital and allow shareholders to take an earlier cash payout from those businesses.

“Credit protections, which are usually less of a concern at issuance, can become critical as economic conditions improve, companies generate more cash flow and deleveraging gives way to shareholder distributions as a priority,” Christina Padgett, an analyst at credit rating firm Moody’s, wrote earlier this month in a report about the trend.

“These covenants may be structured to provide avenues for shareholder-friendly actions that can disadvantage bondholders,” Padgett wrote. “This is applicable to all high-yield issuers, but particularly privateequity sponsored transactions.”

Private-equity firms typically raise funds to buy companies, with hopes of making a profit several years later by selling their stake through an initial public offering or by selling the business to another company.

Darrington said the bond sale also puts Tops in a better position with the financial markets, which could be important once Morgan Stanley decides to cash out of its investment in the supermarket chain.

“Being held by a privateequity company doesn’t last forever, but this does help us let Tops be known better by the financial community,” he said. “It probably makes us a little more attractive to the public equity market.”

Because the Tops bonds can’t be called for redemption for three years, Darrington said Tops’ shareholders are unlikely to push for a sale while that restriction remains in effect. “You would not do a transaction like this if you wanted to sell the company,” he said.

The Tops bonds were given speculative ratings by both Moody’s and Standard & Poor’s. Moody’s rated the Tops notes B3, six levels below investment grade status, while S&P put a B rating on the Tops debt, which is five notches below investment grade.

The rating reflects “a highly leveraged capital structure with thin cash-flow protection measures,” S&P analyst Mariola Borysiak wrote.

Morgan Stanley Capital Partners owns a 75 percent stake in Tops, while the remaining 25 percent is held primarily by an entity consisting of HSBC Holdings and the supermarket chain’s management.

The thawing of the high-yield bond market has spurred a flurry of offerings this year. Companies have issued more than $120 billion in high-yield bonds so far this year, almost double the $64 billion total for all of last year, which was the lowest since 2002, according to data compiled by Bloomberg.

Merrill Lynch’s High Yield Master II index has soared by more than 50 percent this year, which is double the nearly 25 percent total return, including dividends, this year by the benchmark S&P 500 stock index.

drobinson@buffnews.com