Gimme Credit

MGM's overleveraged balance sheet is keeping it busy. Today it announced in an 8-K that it is seeking amendment of $5.5 billion of senior bank facilities and looking to extend the maturity for a portion of them from October 2011 to February 2014. Lenders are asked to approve the deal by the end of February...with those approving receiving prepayments of at least 20% of their commitment (depending on participation) plus fees. Interest expense will increase for MGM but it will be able to issue additional secured debt as permitted under bond indentures. We expect that news last week about an $800 million public secured deal was part of this financing package as the company will be looking to the HY market to raise the money to repay the banks. If successful these moves could increase financial flexibility for MGM, and Moody's placed MGM's ratings on review for possible upgrade today. MGM also said that it will put its Borgata interest into a divestiture trust following its problems with the New Jersey Div of Gaming Authority (see our comment of 1/30/10), stating that it was the best course of action for investors. We think MGM just made a choice between its interest in Macau which is fast-growing and for which the company plans an IPO and the faltering Atlantic City market where the Borgata joint venture with Boyd is located.

Bombardier announced this morning it plans to sell $1 billion of 8 and 10 year senior notes to extend a portion of its near term debt maturities. Proceeds from a transaction would be used to fund a tender offer, also announced this morning, for up to $550 million of the company's outstanding $550 million of 6.75% notes due 2012, $500 million of 6.30% notes due 2014 and EUR $679 million of floating rate senior notes due 2013. The company indicated it could raise the tender cap to as much as $1.25 billion. Last Friday, Bombardier Aerospace disclosed that aircraft deliveries for the fiscal year ended January 31, 2010, were 302 aircraft, down 13.5% from 349 deliveries in fiscal 2009. During the year, the company's aerospace business received 11 net aircraft orders, down from 367 in the year ago period. Business jet deliveries fell 25% to 176 in fiscal 2010, and are forecast to fall another 15% in fiscal 2011. Commercial aircraft deliveries increased 10% last year to 121, but are projected to fall about 20% this year. We still look for Bombardier's credit measures to continuing weakening through the first half of this year before stabilizing. Visibility regarding the timing of a possible turnaround in the business jet and commercial aerospace markets is murky at best. The company's rail transportation business (about 50% of 2009 revenues) continues to improve its revenues, margins and free cash flow (cash flow from operations less capital spending), helping to offset aerospace weakness.

On Friday the heretofore conservative Air Products released a "bear hug" letter disclosing its latest in a series of unsolicited bids for Airgas, this one valued at $7 billion. The dueling lawsuits began immediately. Airgas has already turned down an all-stock offer and a higher bid that was to be half cash/half stock. The latest version is all cash plus assumed debt. Although APD's bid represents a 38% premium, Airgas stock is already trading higher than this bid, reflecting the belief that APD will have to raise its bid or that another bidder will emerge. The cash portion of APD's bid is fully financed but apparently management did not share with the rating agencies its permanent financing plans. We think that unless this involves some meaningful equity issuance, the debt protection measures of the combined companies would be fairly dicey and border on speculative grade credit quality. In the belief that whatever happens APD is likely to be issuing boatloads of bonds, we are initiating coverage with a "deteriorating" credit score. Please see our upcoming report.

Pinnacle's earnings were even softer than we expected. We had recently commented that the regional gaming operators were looking at a tough year --even though their results have held up better than Las Vegas and Atlantic City, there is no getting around the tough competitive environment as more jurisdictions authorize gaming. Pinnacle disappointed the market as competitive pressures in Louisiana and Indiana caused significantly lower EBITDA. Fourth quarter EBITDA fell near 50% to $23 million (even excluding $5 million of severance charges, EBITDA still fell about 40%). Both L'Auberge and Boomtown suffered from the intense promotional environment in the Southeast. The poor results are reflected in deteriorating credit measures as leverage climbs towards 7x. The only good news is that Pinnacle recently announced refinancing of its credit agreement although in exchange for loosened covenants, the size of the facility was reduced. Pinnacle has additional credit issues as it will increase debt to finance the development pipeline. THe license for the President riverboat casino is in jeopardy and even though the President posts negative EBITDA, a lost license could go to a competitor threatening the company's Lumiere property.... Further, Pinnacle placed its Atlantic City land on the market. While we think it's a wise decision not to build on the land, the company will take a big loss on this investment. Finally, we were disappointed in the loss of CEO Dan Lee (see IC of 11.24.09), and while current management may be dumping all the bad news into one earnings period, we doubt it. We are revisiting our outperform recommendation on the new senior notes in an upcoming full report.

Tyson Foods reported much better results for its fiscal 2010 first quarter. Sales for the period ended January 2 rose 1.7%. The Chicken segment accounted for all of the gains as it continued its turnaround. Adjusted operating income rose in each of its four segments. Adjusted EBITDA of $429 million compared to a deficit of ($60) million one year ago. Tyson attributed the improvement to higher volumes, better yields, improved mix and greater productivity. The higher earnings and favorable working capital changes helped boost net CFFO to $548 million in the first quarter. Tyson has done an excellent job of reducing its net debt and maintains a cash balance of $1.5 billion. The company provided a cautiously optimistic forecast for the rest of its FY2010. Please see our upcoming full report.

Sally posted a very good first fiscal quarter (ended December) that saw distinctly positve comps (up almost 4%) and an increase in adjusted EBITDA to $87.4 million (versus $83.6 million in the prior year period) on record sales over $700 million. We have admired Sally's recession resistant business that includes both retail and professional distribution of beauty supplies as well as the company's ability to continue to drive growth by opening new stores in a difficult economy. We forecast adjusted EBITDA this year of over $380 million leading to net leverage under 4x. In our last report we noted that bonds had become pricey and we preferred the senior subdebt due in 2016 over the senior debt because of its juicier yield near 8.8%....the subdebt now trades at 8.2% and we will review our opinion in a full report.

PPL Corp. reported Q4 earnings from ongoing operations of $198 million, up 13% from a year ago. The strong showing brought full-year earnings from continuing operations to $738 million, down just 3% from 2008 despite lower margins in the Pennsylvania delivery segment and less favorable FX rates for international delivery. As usual, PPL Energy Supply contributed the most to ongoing earnings, accounting for $.88 per share (45%) of the $1.95 total. International delivery was second at $.72 per share (37%), with Pennsylvania delivery last at $.35. Supply showed the only year-over-year increase, but that's due primarily to its trading losses in 2008. PPL affirmed its 2010 ongoing earnings guidance of $3.10-3.50 per share, which at the midpoint is a 69% increase from 2009. More than all of the increase is expected of Supply, as guidance for the other segments calls for lower earnings. Supply is calling for strong growth in energy margins, based on PA going to market and its hedged power and fuel prices versus established capacity prices in the PJM. Adding the segment guidance together, we get cash from operations of nearly $2 billion (73% Supply), versus capex of $1.9 billion, leaving just $116 million for dividends, before asset sales of $167 million. Dividends of about $548 million result in a FCF deficit of $432 million before asset sales. More in an upcoming report.

Mohegan posted good first fiscal quarter (ended December 31) results. Although revenue was down year-over-year at the Mohegan Sun casino as we expected, continued cost cutting and revenue gains at Pocono Downs sent adjusted EBITDA up over 15% in the quarter. Adjusted EBITDA on a consolidated basis was near $64 million versus $55 million in last year's first quarter. We expect credit measures to remain stable over the near term. With net debt just under $1.6 billion, net leverage is about 5x, an improvement over year end and interest coverage is 2.8x pro forma recent high yield note financing. We are revising our estimates for fiscal 2010 and will review our bond opinion (we had recommended the senior notes due 2013 most recently at yields of 16% but these have traded up and now yield 11.5%).

Allegheny Energy reported Q4 results considerably better than consensus, resulting in full-year adjusted net income of $397 million, up $6 million from 2008. This was achieved despite weak power prices and low customer demand, primarily the result of good hedges and very good cost control. By segment, Merchant Generation net income was $78 million for 2009, up $10 million, while Regulated Operations (which in the case of Monongahela Power includes generation) increased by almost $16 million to $35 million. Cash from operations (post-WC and excluding interest expense associated with the AE Supply tender offer) was $832 million, versus capex of $1.152 billion and dividends of $102 million, for a "FCF" deficit of $422 million. But AYE obtained securitization (for pollution control) and project financings (for transmission projects) of $553 million to fund the deficit, thereby demonstrating a $131 million surplus. For 2010, AYE provided EBITDA guidance of $1,298 million, with depreciation of $329 million, interest expense of $306 million and a tax rate of about 38%, resulting in (our calculation) net income of $411 million, or approximately $2.43 per share. (That's well above the consensus of $2.24.) This translates into "FFO" (NI + D&A) of $740 million, versus a capex budget of $1,080 million and dividends of $106 million, for a FCF deficit of $446 million, before project/non-recourse financing. (AYE's TrAIL project has already issued $450 million of bonds.) Key to achieving the EBITDA guidance is what happens in the power markets, although AYE still has 82% of 2010 output hedged. AYE currently expects unhedged energy margin to increase by $223 million, doubling to $446 million in 2010, based on 12/31/09 PJM prices, from which its models say it will generate 36 TWh of power, up 38.5% from 2009. That's partly a bullish view on coal dispatch relative to natural gas, and partly a view on recovery in demand -- but from AYE's perspective, its simply what the forward curve is telling it. AYE has now completed its major environmental capex program, with all of its supercritical coal-fired capacity now scrubbed, reducing SO2 emissions by 95%. The capex budget outlook for 2011 is only $695 million currently, although AYE says it has identified $600-900 million of additional transmission investment that could become necessary, depending on PJM decisions and/or discussions with the PA regulator. AYE's PATH project has been deferred by PJM -- deemed not necessary by 2014. If that comes back, there could be an additional bulge in capex in 2015-2016 of about $1 billion. We still like AYE's prospects.

Deutsche Telekom is reportedly considering an IPO of T-Mobile USA. Speculation is that roughly 20% of the unit would be sold to investors, with the company retaining the remainder. T-Mobile is a distant fourth in the U.S. wireless market behind Verizon, AT&T, and Sprint. However, it is not as if the unit is pulling down the company. In fact, T-Mobile USA had been the primary growth vehicle until the recent slowdown. It's true that T-Mobile USA will require substantial capital spending to enhance its network, but cash flow is not a serious concern of the parent at this time. Verizon and AT&T have been rumored as potential buyers but we think antitrust issues would be difficult to overcome. Sprint could use the additional subs but it has its own problems to deal with. Besides the technologies are not compatible, an issue that has plagued Sprint since the Nextel acquisition. Buying its way to prominence is not a likely option either. Top candidates Leap and Metro PCS also have different technologies and focus primarily on the prepaid segment.

S&P today placed its 'AA' rating for Toyota Motor Company on CreditWatch with negative implications. The agency cited the recent recalls and the potential impact on Toyota's overall quality reputation. S&P is concerned that recent developments could harm Toyota's competitive position and business risk profile. S&P indicated that any downgrade would likely be limited to one notch and that its review would be completed by mid-May. The S&P action follows news that Toyota is now being investigated in both Japan and the U.S. for possible brake problems with its best-selling Prius. A recall of the Prius would be another blow to the world's largest automaker. Earlier in the week Toyota reported better than expected 3Q results for the period ended December 31. It also upped its full year guidance for its fiscal year ending March 31 to an operating loss of 20 billion yen, much improved from its prior forecast of a 350 billion yen loss. The raised guidance assumes Toyota will incur roughly $2 billion of costs related to the recall and lost sales. Toyota expects it will forego sales of 80,000 vehicles in North America as it relates to the recalls. This compares to over 2 million vehicles sold annually in NA by Toyota. We believe the impact could be much worse than Toyota's estimates. The company still has not convinced skeptical consumers that it has identified the proper fixes for all of its problems with Sudden Unintended Acceleration. Even Consumer Reports pulled its recommendation on Toyota models involved in the recalls. In the last week the number of lawsuits against Toyota has skyrocketed. At last count Toyota had at least 29 lawsuits seeking class action status related to SUA. The first Congressional hearing begins next week and will likely place even more scrutiny on Toyota and its actions. At least its President Akio Toyoda finally made an appearance this morning and offered an apology to its customers. Unfortunately, Toyota needs to do much more.

Even after its usual slew of adjustments for "special items," Weyerhaeuser reported this morning that it lost money in the fourth quarter ($109 million), more than it lost in the third quarter, and only slightly less than it lost in the prior year's depressed fourth quarter. The impact of the housing market on WY's results is compounded by its presence in both wood products and real estate. Management termed the results "disappointing" and vaguely promised to do better this year. For bondholders the bigger issue is the timing and structure of a potential REIT conversion this year. At the moment it appears that the company's required cash distribution could be as low as $600 million, although this decision remains in the hands of management. Despite much lower capital spending, the company is generating negative free cash flow, so even this amount of cash would need to be borrowed.

State Street said yesterday that it reached a settlement with the SEC and with officials in Massachusetts, resolving a regulatory investigation into "losses incurred by and disclosures made around" certain fixed-income strategies managed by the bank's State Street Global Advisors unit, dating back to 2007 and earlier. State Street agreed to set up a $313 million "fair fund," which includes a $50 million fine and $8 million in disgorgement of fees and interest. The total cost of the settlements, including $350 million in agreements previously reached with clients, is $663 million. State Street said the cost will be fully covered by its existing legal reserve. The SEC cease-and-desist order accuses State Street of misleading investors in the Limited Duration Bond Fund. The Fund was marketed to institutional investors as an "enhanced cash" investment strategy, and had about $3 billion in assets as of June 2007. Many investors were unaware that the Fund had significant exposure to subprime risk. The SEC says that this exposure was further leveraged through the use of reverse repurchase agreements, CDS and total return swaps tied to the outperformance of subprime investments. The SEC alleges State Street made "misleading statements and/or omitted material information," but perhaps the most damning allegation is that, when the subprime collapse became evident in mid-2007, the company provided "certain investors," including clients of internal advisory groups, with details of the subprime concentration. The better-informed investors (including STT's own pension plan) were able to sell their holdings early. In late July 2007, clients of State Street's internal advisory groups held about 20% of the shares in the affected funds; "virtually all" these funds were redeemed by early August. The company allegedly sold "almost all" of the highest-rated assets to meet redemption requests, depleting its liquidity. In agreeing to the settlement, State Street neither admitted nor denied the allegations, but the SEC notes that it has replaced the executives responsible, and reviewed and revised its risk control procedures. While the SEC disclosures make for dispiriting reading, State Street appears to have put the incident behind it. The bank remains well capitalized. Our credit opinion is stable.

Freescale is seeking an amendment to its senior secured credit facilities to extend the maturity of certain term loans to December of 2016, while increasing the interest rates on the loans. The company is also planning to issue $750 million of senior secured notes in a private placement. Proceeds would be used to prepay a portion of amounts outstanding under its senior secured credit facility. In addition, Freescale would like the option to issue other senior secured notes that would rank pari passu with the obligations under the senior secured credit facilities, provided that proceeds from the issuance would be used to prepay amounts outstanding under the senior secured credit facilities at par. Freescale is hoping to push $2.5 billion of debt that comes due in the next three or four years out to a maturity date of 2018 or beyond. We view the filing as a simple admission that the company was over-levered from the beginning.

Colgate yesterday raised its dividend 20.5% and announced a new 40 million share repurchase authorization. Colgate announced better than expected 4Q and full year results on January 28. Net sales were flat and adjusted EBITDA increased 9.8% in 2009. The company reported sequential improvement during the year with volume growth of 3% in the fourth quarter. The share repurchase program would amount to roughly $3.2 billion over the next two years. The dividend will add $179 million to Colgate's annual cash distributions to shareholders. Colgate should be able to largely handle the buyback and dividend increase with free cash flow. In 2009 it generated $1.7 billion of free cash flow and bought $1.1 billion of shares. It ended the year with $600 million of cash and leverage of 0.8x. We don't expect any deterioration in Colgate's credit profile as a result of its actions. Fitch affirmed its 'AA-' rating. The positive credit score reflects our expectation that sales and profit comparisons will continue to be very favorable and Colgate will maintain its conservative balance sheet.

TECO Energy reported Q4 and 2009 results and provided 2010 guidance. Earnings matched consensus for the quarter and finished in the middle of company guidance for the year -- no surprises. For both Q4 and 2009, net income was up with every segment contributing to gains. Q4 net income was up $31.5 million to $53.5 million, with full-year net income of $213.9 million, up $51.5 million. Tampa Electric's 2009 net income was $169.2 million, up $24.6 million and 75% of consolidated net income. For 2009, FFO was $581 million, versus capex of $640 million and dividends of $171 million, resulting in a FCF deficit of $230 million (versus reinvested earnings of $43 million, $5 million of common stock issuance, and a $21 million reduction in accumulated other comprehensive loss). The deficit was covered by working capital liquidation -- in which we include liquidation of deferred recovery clause balances of $137 million for the year. So no improvement in book leverage of 62% of capitalization, but FFO/total debt improved about 2 points to 17%, and interest coverage from 2.2x to 2.5x. For 2010, guidance calls for EPS of $1.20-1.35 per share. At $1.25, net income would be about $272 million and "FFO" (adding D&A only) of $519 million. Capex guidance is now $450 million -- that's a 13% reduction from guidance in early November. After estimated dividends of $179 million, we estimate a FCF deficit of just $90 million, nicely balanced with $93 million of reinvested earnings. The Achilles heel at TECO tends to be (our opinion) anything that isn't Tampa Electric, but managment provided reasonable arguments for why TECO Coal and Guatemala 2010 business drivers may be positive.

Cisco was not the only technology standout on Wednesday afternoon. Arrow reported a 3% increase in fourth quarter revenue, meeting the high end of its guidance. The top line expansion allowed the company to increase margins by 70 basis points. Ongoing cuts in operating expenses were also a key factor. The outlook is even better as management is projecting first quarter sales to increase more than 16% at the midpoint. However, the estimated range is rather wide, reflecting the lack of visibility. Margins should improve again going forward, although Arrow will begin restoring some temporary expense cuts, particularly with respect to employee compensation. In addition, Arrow will pick up expenses from its most recent acquisition. Therefore first quarter margins should be up versus last year but down compared to the fourth quarter. Arrow drove inventory turns up and days sales outstanding down, leading to a return on working capital of 32% (the best since 2007), and working capital as a percentage of sales to 10.5% (a record low). The working capital improvement led to full year free cash flow of $730 million.

The technology sector received a well-needed shot in the arm late Wednesday when Cisco released fiscal second quarter results. Actually it was more the forecast than the results that turned some heads. Cisco issued guidance for third quarter revenue to increase 23% to 26%. And that does not include the pending Tandberg acquisition. Seems like the good ol' days again, particularly if one considers that Cisco is often conservative with its forecasts. Admittedly, the third quarter does contain an extra week so the figures are somewhat inflated. The second quarter was impressive in its own right, with revenue up 8%. Geographically, eight of the company's15 countries reported positive growth, while all of the key product areas experienced strength. Spurred by the substantial top line expansion, EBITDA margins rose more than 500 basis points. Improvements in productivity and scale efficiencies more than offset investments in new initiatives, as well as additions to headcount. However, further investments, including the addition of 2K to 3K headcount over the next six months, are likely to pressure margins in the third quarter. As usual, free cash flow was strong, coming in at $2.2 billion.

Vodafone's shares were up sharply yesterday after the release of fiscal third quarter revenue (Note that the company does not provide full financials for the quarter). But the news is not all positive. Reported revenue rose 10.3%, but on an organic basis, which excludes the merger with Hutchison Australia in June of 2009, revenue declined 2.0%. Management stressed the improved performance in Europe and Africa/Central Europe, but revenue is still falling in these regions (Europe down 3.2%, Africa/Central Europe down 0.5%). Vodafone raised guidance for operating income, but it was mainly due to a decrease in depreciation and amortization. EBITDA guidance was not revised. In fact, management reiterated that the margin decline in the third quarter was consistent with prior expectations. In the first half of the year, EBITDA margins fell 250 basis points. Vodafone also increased its estimate of free cash flow for the year. The bump is due to an improvement in working capital, which is likely not sustainable, and the timing of a tax dividend from Verizon Wireless. So while the news is positive, it is not reflective of a significant underlying improvement in the company's operations.