October 27, 2017 / 3:20 PM / a year ago

CORRECTED-LPC: Office Depot’s M&A loan hits turbulence in retail sector

(Corrects sales comparisons in the 11th paragraph)

By Jonathan Schwarzberg and Andrew Berlin

NEW YORK, Nov 2(Reuters) - A US$750m leveraged loan for publicly-traded US office supplies retailer Office Depot is testing sentiment to the retail sector as online competition, the threat of further technological disruption and rising default rates make investors think twice about lending.

The threat from online retailer Amazon was highlighted on Tuesday when an announcement about the ecommerce giant’s Business Prime Shipping service for users with Amazon Business accounts hit rival Staples secondary loan and bond prices.

Staples’ US$2.9bn loan, which backed the business-to-business part of its August buyout by private equity firm Sycamore Partners, fell to 96% of face value from 99% to yield roughly 6.75%.

The company’s US$1bn 8.5% bonds fell to 90 from around 95, sending yields above 10%, creating a difficult backdrop for Office Depot’s loan.

“This is a sector that no one wants to touch,” a debt investor said. “Amazon’s rapid evolution of technology has really sped up the decline of retail. Defaults in retail are typically a slow burn, but they may end up going a lot faster.”

The US retail sector is currently topping the default list. The bankruptcy filing of Toys R US in September boosted the retail default rate to 7.3% and Fitch estimates that it could hit 10% in 2018.

Goldman Sachs is leading Office Depot’s deal, which finances its roughly US$1bn purchase of information technology services company CompuCom.

The deal is offering investors a spread of 500bp-525bp and commitments are due on October 31. The average secondary spread on B1-rated loans is currently 386bp, according to Thomson Reuters LPC.

The loan offers investors a relatively high coupon for a company that will generate a combined US$234m of unlevered free cash flow (roughly 23% of debt) and has low leverage of 1.3x Ebitda.

Bookbuilding has been slow and investors are already seeking concessions, a prospective lender said.

The company’s sales fell 9.6% from 2015 to the last 12 months ending in June 2017, according to regulatory filings. Office Depot said that it expects sales in 2017 to be lower than 2016 due to store closures and challenging market conditions. CompuCom’s sales have declined 9.6% since 2015.

“It’s hard to get excited about two declining businesses,” a second investor said.

After its failed merger with Staples in 2016, Office Depot has been trying to streamline its business by shutting underperforming stores and cutting procurement and overhead costs.

Lenders are worried about Office Depot’s restricted payments capacity and its ability to incur additional debt, which as currently proposed could allow leverage to rise above the level at the acquisition’s close. Incremental debt as currently proposed would cap senior secured leverage at 1.5 times.

The combination of the companies will create only US$40m in synergies, for a company with a combined US$790m in Ebitda which leaves little room for error in operation, a third investor said.

Office Depot has a liquidity cushion in the shape of a US$1.2bn asset-based lending facility. The company also has US$537m of cash on hand.

Goldman Sachs declined to comment. Office Depot did not return a request for comment. (Reporting by Jonathan Schwarzberg and Andrew Berlin; Editing By Tessa Walsh and Michelle Sierra)

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