Bond rating agency Fitch downgraded its ratings on all classes of AutoNation debt Tuesday, to BB+ (junk status) from BBB-. According to Fitch analyst Karen Ghaffari's research note, the company's pro forma debt will rise to about $4 billion. As a result, AutoNation's debt as a percentage of total capital will rise from 10% to about 29%.
AutoNation ( AN) announced a financial restructuring on Tuesday, whereby the nation's largest car dealer offered to repurchase $1.15 billion of stock and $323.5 million of 9% coupon debt. Specifically, the company will commence a tender by March 10 to buy back 50 million shares (19% of the company) at $23 apiece, and it will raise some of the funds by selling $900 million of new long-term notes. The stock gained 7% Tuesday on the heels of this news, closing at $22.26. It's no wonder, considering that AutoNation said it expects the recapitalization to add 8 to 10 cents a share to annual earnings. It's also worth noting that ESL Investments, the hedge fund of famed investor Edward Lampert, owns about 29% of the company. Lampert has said the fund will tender all of its 77.1 million shares. Of course, the 50 million shares to be repurchased by the company will be allocated on a pro rata basis, and that means ESL would retain a 29% stake in AutoNation if every investor also tried to sell his shares. Two questions investors are likely asking themselves: First, how can the company afford this buyback? Second, should I buy AutoNation or view the tender offer as a selling opportunity? In other words, should I do it? Let me first say that I never like to see a company borrow money and leverage up its balance sheet to either repurchase stock and/or pay a dividend, as AutoNation is proposing. Even so, there are times when it's acceptable for a company to increase its financial leverage, particularly when operating in a capital-intensive business while interest rates are low. As AutoNation is expecting, this strategy can also improve profit per share, as it will lower the amount of stock outstanding. According to recent Securities and Exchange Commission filings, AutoNation had $243.8 million of cash on the balance sheet. The company's available financing includes a proposed $300 million term loan and $150 million available under a bank credit line, but the company will need to fill in the funding gap with a new $900 long-term debt offering. But not everyone was as enthusiastic about the tender offer strategy. To watch David Peltier's video take of this column,
click here .