Increased optimism around Canadian M&A activity has Canadian bond investors considering more safeguards to protect their investments in the face of debt-financed acquisitions that can lead to the suppression of an issuer's credit ratings and devaluation of its outstanding bonds. In response, the bondholder advocacy group Canadian Bond Investors Association (the CBIA) recently published a discussion paper advocating for more robust safeguards to be introduced or to broaden existing protective provisions in the debt covenants of Canadian bonds. Chief among the CBIA's recommended safeguards are change of control "put" options that provide bondholders with the option to force debtor companies to repurchase all or part of their outstanding debt at a premium in the event that the debtor experiences a "change of control" event and is effectively acquired by a new owner.
According to the CBIA's recommendations, model protective covenants should define a "change of control" event as an occurrence of both (i) a ratings change event, whereby a bond loses its investment grade rating or, in the case of non-investment grade bonds, where a bond's rating decreases one or more gradations, and (ii) one or more of the following change of control events:
- a merger or amalgamation of the debtor company with another person (except where the merger results in the debtor company holding more than 50% of the surviving entity);
- the acquisition of 50% or more of the voting stock of the debtor company by another person or group of persons;
- the sale of all or substantially all of the debtor company's assets;
- the liquidation or dissolution of the debtor company; or
- a change in the majority composition of the board of directors within any 12 month period.
Poison puts are not a new phenomenon. Growing in popularity in the United States at the height of the leveraged buyout boom in the 1980s, poison puts were introduced as a way to protect bondholders in the event of a leveraged transaction. Their popularity surged again in 2007 following an increase in highly leveraged acquisitions and are now a standard feature in American corporate bonds at the BBB tier. However, recent data compiled by Bloomberg indicates that only 13% of the investment-grade debt securities sold in Canada feature poison put provisions. The CBIA also noted that such provisions are even lacking in low to non-investment grade debt securities.
Canadian companies may be beginning to take note, though. A sample of publicly available bond indentures from Canadian companies over the last year indicates that just over one-half (56%) of indentures offered put options with at least one of the five recommended change of control triggers. The most common trigger was the second scenario (simple acquisitions of 50% or more voting stock) with all but one indenture providing protection for this event. Not one indenture covered all five triggers and the least common trigger was the fifth scenario (a change in the composition of the board) which was found in only 20% of the indentures reviewed.
Whether these statistics are indicative of a trend toward an increase in poison puts and broader change of control triggers is unclear. However, the CBIA's recent paper is an important reminder to acquirors, particularly buyout firms shopping in Canada, to be mindful of the protective mechanisms incorporated in corporate debt instruments in valuing targets. It is also another factor that boards of acquirors and targets will need to carefully weigh when evaluating transactions that trigger these protective features.
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