Although issuance actually picked up on the week ($20.5 billion vs. $13.1 billion the week before), the weighted average credit quality deteriorated (to A-/BBB+) and the deals were on average smaller ($420 million). The primary market continues to be open to a wide range of issuers as this week's calendar shows. Navistar (Ba1/BBB-), a cyclical industrial, was able to issue $400 million in debt and the deal was reportedly three times oversubscribed. In addition to Navistar, another $2.5 billion of split-rated and high yield credits brought debt to market. While the market for straight debt deals posted an average week, the convertible market was on fire due to the rally in equities. Thus far in May, a record $14.2 billion in convertible debt was issued out of a total $50.3 billion year to date.
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Citigroup: Spotlight on the Credit Card Business
On the debt side we, see significant spread tightening opportunity versus American International Group. AIG trades more technically, but outtrades Citi by some 20 - 25 bps in the ten year sector. We think CEO Greenberg envies Citi's position in the U.S. and will be hard pressed to duplicate it. Similarly on the equity side, AIG's P/E multiple skirts 30x while Citi's nips at 20x. We believe that Citi has more reliable and sustainable revenue drivers than AIG and that a multiple in the middle (25x) is foreseeable in the next two years. Our target stock price for Citigroup is $80/share by 2003 which puts it on a growth rate of 15% annually.
Northrop: Fleet Weak?
We review the S-4 filing outlining the specific terms of the Northrop-Newport News proposed deal. The previously announced 75%-25% equity-cash split is not what is now being presented, and the cash component looks like it could creep considerably higher. The stock-cash mix across different NOC stock price levels and pro forma financials point toward more incremental credit risk than we would have factored in based on the originally indicated terms. While NOC is not likely to risk below investment grade ratings and the numbers do not merit junk status, NOC is narrowing its comfort zone with S&P.
Lucent: Anxious Bride With Debt Dowry?
Potential Alcatel merger raises the stakes for Lucent bondholders decidedly on the upside, but a deal collapse would be major perception blow to company. A stock-financed merger would bring an end to Lucent bondholder pain even if the screaming on the screen would indicate a transfer of agony to the Alcatel shareholders. The big worry for Alcatel shareholders is that such a move would bring balance sheet and financial risk in the form of LU's black hole of vendor financing exposures and ongoing restructuring initiatives. For LU, a merger would spread the risk of the vendor financing exposure across a larger global revenue base, but the risks for LU bondholders is that a protracted due diligence process could in theory delay the sale of fiber unless the deal gets done in two parts.
Southern "Bronx Cheer": Wachovia Rebuffs SunTrust
This week, Wachovia's Board of Directors rejected SunTrust's hostile offer and reaffirmed its commitment to its planned merger of equals with First Union. It based its rejection on four reasons. 1, SunTrust has produced lackluster growth. 2. SunTrust's deal poses higher integration risk. 3. SunTrust's deal does not compensate for the first two risks: lack of future earnings growth or implementation risk. 4. There is no dividend advantage with SunTrust's deal.
Not in My Pocketbook: Bush Energy Policy Emphasizes Economic Growth
Jimmy Carter taught American politicians that one sure way to be a one-term President is to call upon the citizens to sacrifice in the name of conservation. President Bush's National Energy Policy demonstrates that he has learned that lesson well. The report focuses attention on the serious energy problems in the US and the need to take immediate steps to increase energy and power supply. The winners in the current crisis (refiners, E&P companies, power generators, equipment manufacturers and oil field services providers) will keep right on winning. Losers (power intensive processing industries, power companies with unbalanced revenue streams vs. cost bases, petrochemicals, heavy manufacturing, transportation) will keep losing for some time.
Ford and Firestone File for Divorce
Citing a breakdown in trust, Bridgestone/Firestone (Baa1/BBB+) is terminating its century-long relationship with Ford (A2/A). At issue is the reputation of Ford's best selling SUV and the Ford name itself, tarnished by a recall in August to replace Firestone tires. From Firestone's perspective, Ford has been unwilling to acknowledge safety concerns that relate to the vehicle, or the vehicle's interaction with the tires, versus the tires alone. According to John Lampe's (Firestone's chairman) letter to Ford's Jacques Nasser, "the basic foundation of our relationship has been seriously eroded." Existing contracts between the two companies will be honored but no new agreements in the Americas will be drawn.
Ford Jacks Up Tire Reserves
Ford has taken the offensive in the great tire imbroglio by announcing a "precautionary and preventive recall" that will generate an after-tax restructuring charge of $2.1 billion. While Ford clearly has stated that they do not want to assign blame, the marketing risks associated with doing nothing were high in terms of additional image problems as well as contingent liability exposure. On the other hand, the slew of detailed studies serve to, in effect, assign blame, so Ford is acting prudently in the context of managing contingent liability exposure. While the legal exposure will be played out over the intermediate term and the course of the cycle, the more immediate financial impact can be measured on several levels.
Auto Leasing-Traffic Still Heavy
We expect a new round of scrutiny around the recent leasing boom and what risks it may present to the near-term earnings outlook and balance sheet quality of the captive auto finance units. The quality of the residual values on operating leases has been questioned for some time and it is an area where the auto companies show understandable unity in defending leasing practices given the balance sheet stakes involved. Interestingly, Ford and GM have started to part ways on their relative aggression in the leasing area during 2001.
Sandy Weill Moves South of the Border
The President of Citibank Canada said that the parent company was probably not interested in banks in Canada due to less attractive growth and return prospects than other regions. While the regulation up North is relaxing, with up to a 20% stake available to foreign firms, it still wasn't enough. Now we know why. Citigroup's CEO Sandy Weill had a bigger appetite than 20%, when he announced that Citi would purchase Banacci for $12.5 billion: half in stock and half in cash. The rating agency's applauded the deal as well as most stock analysts. We continue to love the bonds as a quality play, and love the stock due to its quality earnings stream. P/E multiple expansion of a few points should follow in next twelve months as Associates, Banamex (Banacci's brand name), and other acquisitions kick in.