This week ADT Security Corp, the provider of home security services and alarm systems, came to the market to refinance some of its higher coupon unsecured debt (their 9.25% 2023’s). The company was looking to do this through a mixture of 5-year and 7-year secured and unsecured debt. By way of background, secured debt is secured on the company’s assets and ranks higher in any potential future restructuring than unsecured bonds. For this reason, investors demand a yield premium on unsecured bonds.

Given the recent performance of new issues in the market, the general expectation was that the books would be filled and the company would print paper at their desired price. However, the deal was only partially refinanced with the unsecured leg of the structure dropped due to lack of demand.

So what happened?

It’s unlikely this deal was pulled due to general market fatigue as supply has been shallow this year and cash balances, while shrinking, are still high. Rather, the market appears to have become concerned at what I would describe as very loose covenants within the bond indentures. Based on our own analysis, the covenants have very little room for new debt at the secured level of the capital structure. However, the business has loose debt incurrence limits at the unsecured level, which theoretically could allow the majority shareholder, Apollo, to increase debt in the business in order to pay itself a dividend. However, with only 150 basis points premium for buying the proposed unsecured tranche versus the secured tranche (thereby facilitating the dividend to Apollo), it was no surprise that the deal failed to get over the line. We have no major fundamental concerns with ADT as a business, but we put considerable focus on structures and covenants when making investment decisions and on this occasion the price talk was simply too tight for us (and also the market).

Should we be worried at this development? No, not at all. It tells us we are in a market where investors have been rational enough to push back on a deal where valuations don’t fully compensate for the risk. This is a healthy sign of market conditions, it’s not something to be alarmed about.

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