Tesco (TSCOLN; Baa3, BBB-, BBB-; S) Event of Default

Market colour we have is investors are starting to eye low cash price Tesco lines (€29s at €86 & £28/30s at £90) in the hopes of triggering a Event of Default on completion of Tesco bank sale (expected to close in 2H this year) - we see the size of the sale missing thresholds - but we have some uncertainty on if impairments & remeasurements it recorded on the bank assets held for sale will be used by bondholders to push sale assets above thresholds.

Regardless we are cautious of similar situation to Essity where company legal advice and bondholders (currently pricing -ve spreads) are left on separate pages. We remove our screen cheap on Tesco 29/31s flatteners (flagged at +45bps at +39 now). Net we caution investors of being short any low cash px Tesco's.

• Default clause includes ceasing of business in 'major subsidiaries' - latter defined as one whose "profits before tax and exceptional items or whose net assets (in each case attributable to Tesco) calculated by reference to its latest audited accounts represent ten per cent. or more of the consolidated profits before tax and exceptional items or net assets" (see event of default clause in bond docs for full).
• The banking op's being sold to Barclays (which excludes insurance, ATMS, travel money & gift cards) had a adj. operating profit of £85m for FY23 & at completion net asset value of operations being disposed were estimated at £1bn or 2/3rds of Tesco Bank's Net asset value (company statement, 9th Feb '24). These miss thresholds on FY23 numbers; group adj. operating profit at £2.6b & statutory at £1.5b - even if we take full Tesco bank profits that's 5.4% (£143m) on adj. & 8.7% (£132m) on statutory. Net assets for group was at £12.2b which on the £1b estimated above is still below threshold 10%.
• We got updates to those values in FY24 prelim results (10th April); Adj. Profit on discontinued bank operations was lower yoy at adj. £79m (statutory was negative on the FV remeasurements) again both well missing against group £2.8b (adj. and statutory). Net assets was at £576m against £11.6b in total (misses threshold) - but it did note it recognised a -£732m loss on remeasuring the disposal group to FV less costs to sell - adding back this in full would bring one over thresholds.
• Note some of the £732 is measured as goodwill impairment (£211m) & it includes £7m on costs of sale. Second reminder it did say 2 months earlier NAV on sold component was around £1b which would be below threshold on FY24 total NAV. Still whether adjustments will be used by bondholders to claim default is what holds us back from certainty/fighting 29s as does the skewed upside on cash price/spreads in the case of call vs. adjustment to FV.
• Finally & as a aside default does not necessarily mean par call - co could attempt a tender or a consent solicitation to exclude this transaction.

• Swedish consumer goods co Essity (Baa1/BBB+) faced demands from bondholders this year on alleged event of default following divestment of its 52% stake in Vinda (SEK19b) in late December. Mgmt has been firm on legal advice that it is not a cessation of business & that the the stake only made up 8.5% of sales (vs. floor 10% requirement). It added 2 weeks ago in earnings that the firm stance had not changed. Bondholders apparently disagree with curve dislocated/negative spreads - 31s at cash price of €90 and spread of Z (-80).
• In 2022 Chemicals co Solvay (Baa2/BBB) spun-off its specialities segment into Syensqo (~€6b+ of the €10b in in FY21 sales) - similar wording on event of default triggered speculators to bid the lines up & soon after co gave in and called lines at par (early September) - the 29s were at €85 only a month earlier.