Tobacco king Altria Group (MO 0.49%) has been one of the most successful stocks in stock market history, and long-term investors have seen massive returns on their investments. Although most investors focus on the fundamentals of a company's business, behind Altria's Marlboro brand and other products is a host of financial professionals looking to make the cigarette giant's operations as efficient as possible.
Yet sometimes, actions taken years ago end up having costs later on. Recently, Altria announced that it would restructure its debt, and although the rationale for the decision makes sense, it shows just how costly relying on the capital markets can be during tough times.
Image source: Altria.
Altria moves to trade one debt for another
The announcement that Altria made involves a cash tender offer for long-term unsecured notes that mature between 20 and 25 years from now. Under the offer, Altria will seek to purchase $1.4 billion in debt, including notes paying a 9.95% coupon rate due in 2038, and notes paying a 10.2% coupon rate due in 2039.
In order to give an incentive to the investors who currently own this debt to sell them back to the company, the price that Altria is willing to pay will be well above the par value of the bonds. Specifically, Altria will calculate the appropriate price above par value that will correspond to the current interest rate environment, using rates on 30-year Treasury bonds as a baseline and adding 1.67 percentage points to that baseline rate.
An example will make it easier to understand how this will work. Right now, 30-year Treasury bonds yield around 2.3%. When you add the 1.67 percentage point adjustment, you get a reference rate that's close to 4%. Because the bonds carry coupon rates of around 10%, the value of Altria's bonds is much higher than their face amount.
Using a bond calculator, for every $1,000 in bonds an investor owns, Altria is likely to pay roughly $1,850 to $1,900, based on current interest rates. That's consistent with current market prices for the bonds, which range from $1,835 per $1,000 on the 2038 note to $1,877 per $1,000 on the 2039 note.
Why Altria is doing this
Altria is offering new notes in order to finance its tender offer. The stated purpose of the move is to reduce the weighted average coupon rate of its outstanding debt overall, along with its obligations for ongoing interest expense. Altria also believes that the move will extend the weighted average maturity of its debt.
According to its final term sheet, the refinancing should accomplish those purposes. The company expects to offer $500 million in 10-year notes and $1.5 billion in 30-year notes. The coupon rates on the notes will be 2.625% for the 10-year and 3.875% for the 30-year, and the pricing at a slight discount to par value means that the effective rates to maturity on the bonds will be slightly higher than the indicated coupon.
An opportunity lost
Yet the major problem with Altria's decision isn't so much that it has chosen to refinance the debt, but rather that it took on the debt in the first place. Both of these notes were issued during the financial crisis in late 2008 and early 2009, and the high coupon rates reflect the difficulty in raising capital at that time. It's because of those temporarily high coupon rates that Altria will have to pay so much more than par value for the bonds.
Moreover, Altria could have paid less if it had moved more expeditiously. This isn't the first time that Altria has made offers to investors to tender these bonds. For instance, a 2013 offer paid investors between $1,500 and $1,600 for the bonds, reflecting how much interest rates have fallen just in the past three years. At the time, Altria had more offers than it was willing to accept, and had it been willing to dedicate the cash to the effort, it could have saved money on the buyback.
It's true that, by taking advantage of favorable market conditions, Altria will soften the blow of the costs of refinancing its debt. Yet if all bondholders tender their Altria bonds, then even the $2 billion in new debt won't be enough to pay for the bonds that initially raised just $1.4 billion for the company. Altria's need for capital eight years ago is finally coming back to haunt it, and the cost of the tender makes the entire episode an unfortunate event for Altria.
