Sensata Technologies Holding NV represents everything that wasn't thought possible during the recession: a private equity portfolio company selling junk bonds in conjunction with a billion dollars in covenant-lite debt -- in the auto industry. And yet Sensata boasted one of the lowest-yielding junk-bond issuances in decades.
Almelo, Netherlands-based Sensata, which makes sensors and controls used by auto and aerospace companies, issued $700 million worth of 6.5% senior notes May 6. That was on top of a $1.1 billion, seven-year covenant-lite term loan and a $250 million, five-year revolving credit completed May 12. The proceeds went to swap out the entire credit structure of a company that just two years ago looked like it would be yet another blight upon private equity.
If the industry could give a fist pump upon this bond issuance, it would: Rated B3 by Moody's Investors Service and B by Standard & Poor's, the notes tied for lowest-yielding bond for that rating combo in the last 20 years, according to data from Barclays Capital. What's more, average yields among all bonds with ratings below investment grade -- that is, junk -- fell to 6.61% May 16, a second consecutive week of new lows for the U.S. High Yield Barclays Capital Index. The yields are a result of the Federal Reserve maintaining near-zero Fed funds rates and a decline in Treasury yields.
"[Sensata] got it right at some point," says Bradley Rogoff, Barclays' head of U.S. credit strategy. Rates are not only low in the high-yield market, they're low in the loan market as well, where issuer-friendly cov-lite loans are proliferating. One out of every four loans is cov-lite, according to Standard & Poor's Leveraged Commentary and Data. As a result, now is a good time to get an LBO or refi loan. "The cost of all-in financing is extremely low if you're looking to do a leveraged buyout or if you're looking to refi," says Rogoff. "For take-privates, it's the best opportunity they could hope for."
Mind you, Sensata's situation should be differentiated from new issuances. It is a recognized credit that has delivered results and successfully went public in March 2010. But it's a stark contrast to compare Sensata's situation now with when it was a highly leveraged company rated Caa2, or a credit risk of "extremely poor quality."
Bain Capital LLC had leveraged up Sensata with $2 billion in debt in a $3 billion April 2006 LBO. Bain and a group of co-investors sank $985 million of equity into the deal. During the last quarter of 2008, Sensata reported a 28% fall in revenue, along with a 34% drop in adjusted quarterly Ebitda. Sensata's net interest expense was up to nearly 80% of its Ebitda by then. That prompted Moody's to downgrade its corporate family and probability of default ratings to Caa2 from B3.
Fast-forward two years, and Sensata's interest expense for full-year 2010 was just 22% of its Ebitda, and it even expanded its issuance by $100 million because of eager bond buyers with growing piles of cash. Moody's upgraded Sensata's corporate rating to B1 from B2 as a result of its new debt package.
The absolute spread on these bonds, which reflects what bond buyers receive to compensate them for volatility above Treasuries, is not at its lowest point either. The all-time low for the option-adjusted spread was in May 2007. Investors haven't been scared off, and money flows into high-yield funds driving issuance. Net inflows into junk funds were recorded in 15 of the first 19 weeks in 2011 totaling $7.3 billion, compared with $2.3 billion in the same period last year, according to Lipper FMI Strategic Research.
Though the Sensata debt is in demand, the question remains as to just how much of this PE-backed corporate debt the market wants. Even the ratings agencies are split. S&P, unlike Moody's, did not upgrade Sensata, mainly because it was a PE-backed company. The "majority ownership by Bain Capital remains a risk, since it relates, in our view, to the company's financial policy," says S&P's ratings note.
Larry Post, a veteran high-yield money manager with Post Advisory Group LLC, says there's reason for caution, but that some companies represent good value. "If they make sense from our standpoint, we can buy them within limits, depending on the quality and the yield," he says.