Nobody Does A Buyback Like Sara Lee (SLE)

By Eugene Bukoveczky | July 25, 2007 AAA

Sometimes the battle lines in a company are drawn between shareholders and bondholders. Take the case of Sara Lee Corp. (NYSE:SLE). Right now the company is sitting on a $2.2 billion cash hoard and these two groups of stakeholders are at odds over what to do with all that money.

Shareholders Want Buybacks
For their part, stockholders are keen to have management accelerate its existing stock buyback commitment. To do so would help prop up the share price, which is down 5% on a year-to-date basis. About $1.5 to $2 billion of existing buyback commitments are outstanding, and while management continues to remain tight-lipped about the take-up amount for fiscal 2008 (year-end June). There is some speculation that the buyback amount will be increased by $500 million.

This buyback would send a positive signal to the markets and support the stock price. Not only would such a move gain the favor of stockholders, but it would also send a tangible signal to the markets that management is fully confident its so-called Transformation Plan can deliver future 12% operating margins. Recently, the company's operating margin has been running at half that rate.

The plan involves making meaningful capital expenditures over the next few years in an effort to inject new life into some of the more mature brands in the company's product stable. Should this plan succeed, then the stock would have to be seen as a bargain at current share price, thus justifying the investment in a share buyback. (To find out more, see A Breakdown Of Stock Buybacks and The "True" Cost of Stock Options.)

Bondholders Want Reduced Debt
Sara Lee bondholders have a different set of priorities. They'd like to see some of that spare cash applied to paying down some outstanding debt. The company's current debt/EBITDA ratio stands at 4-times; that's more than twice the average leverage for other major food producers like Kellogg Company (NYSE:K), General Mills Inc. (NYSE:GIS) and Kraft Foods Inc. (NYSE:KFT). Another reason for the bondholders to be nervous is the fact that the company currently has negative free cash flow. That narrows the margin of safety with respect to the company's ability to cover its debt payments.

Reducing debt levels also would help narrow Sara Lee's current bond yield spread over U.S. Treasury Bonds. At roughly 100 basis points, its about 30 basis points higher than the yield on bonds issued by comparable food producers; a telling sign that bond market views the company's bonds as a riskier choice at this juncture.

Leveraged Buyout Speculation
Another reason why Sara Lee's bond spread is wider than its peers is the continued speculation that the company could be subject to a leveraged buyout (LBO). The thinking is that the company could be bought out by a group of private equity investors who would then take the company private and either restructure it or sell off individual pieces to turn a profit. If the presumed new owners were to instead invest heavily into turning around the company, then that could involve raising new funds by issuing new company debt - a scenario that existing bondholders are wary of.

Don't Bet On It
While there is an obvious temptation to buy the stock now on the hope that an LBO does come about, the odds appear to be fading that such a deal will happen at any point in the near future. The required investment needed to "renovate" not only the company's mature brand portfolio but its entire business infrastructure, could be a lot more than people are presuming. The growing realization that this could be the case, combined with recent signs that lenders may now be backing away from funding any further private equity deals, appear to be deflating hopes of an LBO along with the share price. Anyone buying the stock now will be betting that the current management can turn things around with its own recovery plan; a plan that will have a hard time succeeding given that intense competition is limiting pricing power and rising costs due to biofuel driven commodity price inflation are pressuring margins across the entire food industry.

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