Rouse bondholders take hit as value falls after deal

September 08, 2004|By Jay Hancock

NOT EVERYBODY who invested in the Columbia-based Rouse Co. is thrilled with the company's $12.6 billion deal to sell itself to General Growth Properties Inc.

While Rouse shareholders have seen the value of their stakes soar by a third, Rouse bondholders have gotten hammered. Fearing that General Growth's already-large debt would hurt the post-merger creditworthiness of Rouse bonds, investors dumped the securities after the deal was announced last month.

Depending on maturity dates and other attributes, Rouse bonds have fallen by as much as 7 percent. That's a ton for a credit issue.

The bonds are held mainly by insurance companies and mutual funds. Big holders include Prudential, Metropolitan Life and Baltimore's Monumental Life. While unhappy bondholders can't stop the merger, the hit to Rouse's debt mars a deal that was otherwise cheered on Wall Street and raises questions about whether General Growth has bitten off too much.

"It hurt the bonds pretty hard," says Paul D. Corbin, fixed-income chief at Baltimore's Brown Advisory. "We probably will be looking to come out of the bonds for at least some of our clients. We do believe there is a strong possibility they'll be downgraded by at least one of the rating agencies below investment grade."

Below investment grade, of course, means "junk" or "speculative" in less-polite circles.

Some Brown funds are barred from owning junk bonds, so the firm would have no choice but to unload if ratings firms lowered their grades on Rouse paper from the present BBB-minus, which is just over investment grade.

Brown Advisory holds $9.3 million in face-value amount of Rouse bonds expiring in 2009 and paying 8 percent interest, Corbin said. Their price fell from $1.14 per dollar of face value before the deal announcement to less than $1.11 afterward.

Another issue, paying 5 3/8 percent and due in 2013, plopped from over a dollar to less than 93 cents, a larger drop reflecting a longer period of risk before bondholders are scheduled to get their principal back.

Rouse bonds paying 3 3/8 percent and expiring in 2009 fell from almost 97 cents to about 93 cents.

Corbin believes Rouse bonds have fallen too far and will recover, but the ratings agencies aren't very encouraging.

"We put all the ratings under review for downgrade," says Philip M. Kibel, a debt analyst with Moody's Investors Service in New York. With Chicago-based General Growth, he says, "you have a lower-rated company with a transaction that looks to be highly leveraged buying the Rouse Co."

The deal blindsided and presumably embarrassed Moody's, which had assigned a "positive" outlook to Rouse a day before the announcement and then had to backtrack.

While credit analysts acknowledge that combining Rouse and General Growth will deliver greater market share and other benefits, they worry that an already debt-heavy General Growth will be even more encumbered after it pays for the Rouse stock and assumes $5.4 billion in Rouse liabilities.

Of particular concern is General Growth's adjustable-rate debt of more than $3 billion, which could drastically boost its interest expense and hurt its ability to repay lenders if interest rates rise. General Growth has tried to hedge against rate swings, but that's no guarantee.

"We were looking at this rating improving," Jeanne M. Sarda, a credit analyst for Standard & Poor's, says of Rouse. Now, she says, "that is certainly not the case. It is either a hold steady or come down."

The combined Rouse-General Growth operation will have $23 billion in debt - more than 70 percent of its capitalization, calculates Kathleen Shanley, an analyst at Gimme Credit Finance in New York. Rouse's cash flow covers 2.8 times its interest obligations. By contrast, the post-merger company is projected to generate cash equal to only 1.6 times interest.

That's a much thinner cushion against potential default and is below the 1.7 coverage ratio required by Rouse's bond contracts, Shanley wrote in a recent report. General Growth typically approaches bondholders, she adds, "with what the nuns at Sacred Heart School used to call a `bold and brazen' attitude."

General Growth CEO John Bucksbaum was unavailable for comment yesterday, a spokesman said. But the company acknowledged bondholders' concerns the day the deal was announced, saying it would address the interest-coverage requirements by keeping Rouse debt in a subsidiary instead of mingling it with other liabilities. That's small comfort, say bondholders who fear the Rouse entity might take on new debt later.

What matters is corporate-wide debt, and for General Growth that is about to swell by billions as it borrows cash from banks to buy Rouse. Rouse shareholders are benefiting greatly from this deal, but at Rouse bondholders' expense.

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