Tuesday, August 11, 2009

Sometimes (Presumed) Dilution Does Kick In

Suburban Propane Partners announced that it will be offering 2.2 million limited partner interest units, priced at $41.50 per unit. That price would have made for an adequate discount as of yesterday's close, but today's doesn't. The stock dropped 7.47% in regular trading to close at $40.75. Given this drop, the secondary is going to be a difficult sell. It may be undersubscribed.

The proceeds are being used to buy back some of its 6.875% senior notes due in 2013: up to $175 million of them by tender offer. If the secondary offering is completely sold, then the gross proceeds will be $91.3 million. (Net proceeds could be $90 million.) Those notes are being bought around face value: anyone who tenders before 5 PM ET on Aug. 21st gets 101.25% of face, and anyone who tenders after that time but before 9 AM ET on Sept. 8th gets 98.25% of face.

At those prices, the secondary offering may be dilutive to earnings. Suburban pays 8.10% at $40.75. At $41.50, it pays about 7.95%. With net proceeds, it might be about 8.05%. The yield to maturity of any bonds picked up for 101.25% of face will be about 3%. Clearly, for this part of the bond buyback, Suburban's going to be paying more.

2.2 million extra shares of Suburban, with an 83 cent quarterly dividend, is going to mean an extra payment of $1.826 million each quarter if the dividend stays the same. Given Suburban's pattern of dividend increases, that's not likely. It seems prudent to bump up the indicated annual dividend expense of $7.304 million to an even $7.5 million. I'm assuming that the secondary offering will be completely sold, and the net proceeds of such will be $90 million.

If Suburban gets $175 million of bonds at 101.25% of face, for a net bill of $178.06 million, and $90 million from the secondary, then it will be required to pony up an additional $88.06 million in cash plus any after-deal fees for the tender offer. I'm assuming that those fees will be an extra $2 million, which would bump up the cash commitment to $90.06 million. As of June 27th, it had $256.1 million in cash and cash equivalents, which is more than enough. The annual interest savings on the bonds will be $12.031 million. As noted above, the added dividends will be about $7.5 million. Increasing that $7.5 million estimate to $7.531 million leaves a gross cost savings of $4.5 million. Assuming that the cash-and-equivalents can yield 2%, then the annual cost of the foregone cash would be $1.801 million. This figure leaves Suburban with a net savings of about $2.69 million annually, or 7.7 cents per share after dilution. If the offering is fully subscribed, and all else remains equal, then it will be accretive to earnings.

On the other hand: if the offering isn't fully subscribed, then it may be dilutive. If $117 million or less of the bonds are tendered, given the above assumptions, then it will be. At that level, the dividend cost of the new limited partnership units exceeds the interest-savings gain on the bonds.

There is a chance that the tender offer will pull in all of the bonds, As noted above, the yield to maturity is about 3% at the higher tender price, and the use of a time-competitive tender structure may encourage a lot more tendering. Nevertheless, the "judgment of the market place" says that the buyback of the bonds will be dilutive. If the market is wrong in this judgment, then Suburban units have gone on sale.

There's also the other side to consider, from a balance-sheet perspective. What if all of the bonds are tendered at the higher price and no shares are sold in the secondary? That would produce maximum accretion to earnings, but it would also subtract $178.06 million from Suburban's cash balance. As of June 27th, the company has $400.49 million in curent assets and $146.53 in current liabilities for a current ratio of 2.73. Having to pay $178 million would reduce Suburban's cash balance to about $78 million, if all else current-related remains equal, and its current assets to $222.43. That outcome would leave a current ratio of 1.52. Consequently, this possibility would leave the company fairly strapped, even if its debt-equity ratio would end up well below 1.

Disclosure: As of the time of this post, I have a live buy order for some Suburban in my actively-managed Marketocracy mock fund.

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