Wachovia analyst says Omnicom needs a credible refinancing strategy

By Ronda Fears

Nashville, Tenn., June 27 - Omnicom Group Inc. needs to articulate a credible refinancing strategy to fix its over-reliance on short-term debt, said Wachovia Securities, Inc. convertible analyst Sri Nadesan.

"The company's decision to use short-term debt to fund long-term capital has given rise to the need for refinancing a significant amount of debt in 2003," Nadesan said in a report Thursday.

"The company has to put contingency refinancing plans in place irrespective of what the prospects are for the company's share price over the course of the next year or so, we believe."

The company could escape the convertible puts in 2003, which on the two 0% issues total $1.75 billion, if the stock price recovers substantially from current level, he noted. It also has $300 million in a bank revolver coming due in 2003.

But the analysts added: "It is worth keeping in mind that the convertibles have annual puts. Therefore, the issue of refinancing the convertibles could become an annual exercise in anxiety every time the stock price falls below a certain threshold."

Thus, the refinancing issue should be addressed on a long-term basis.

Also, Nadesan said Omnicom needs to clarify if it plans to change its acquisition spending, given the current skeptical capital markets.

"Although the company enjoys terrific advantages, such as high interest coverage ratios, no immediate EPS dilution and tax-deductible 'phantom' interest expense, with its two zero-coupon convertibles, these bonds have introduced a high degree of financial risk in the company's balance sheet," Nadesan said.

"We believe the company needs to reduce this risk even at the cost of losing some of these benefits."

Wachovia estimates Omnicom could require $1.52 billion in funding during third quarter 2003.

Currently, Omnicom has only $1.18 billion available on its credit facility. This credit facility, if tapped, would become due no later than April 25, 2004.

"The company needs to raise additional funding for $348 million, we estimate, to meet its peak funding needs in the third quarter of 2003," Nadesan said.

"Alternatively, the company may have to reduce its acquisition activity to about half of that in the past two years and/or consider cutting its common dividend."

The company has been using implicitly short-term debt, mostly the putable convertible bonds and bank debt, to fund long-term capital uses, such as acquisitions and share repurchases. The analysts said Omnicom should consider lengthening the duration of its debt.

"The company at this time has not publicly articulated a strategy to refinance its short-term debt. We believe the company needs to do this instead of relying on a hoped-for recovery in its stock price," Nadesan said.

"If the company were to refinance its short-term zero-coupon convertible debt with a coupon paying longer term debt, the company's coverage ratios will likely be negatively affected.

The two convertible bonds are putable at the investor's option in February 2003 and July 2003.

"Because of the decline of OMC's stock price over the past week, we expect that when the company files its second-quarter 2002 results it may have to classify the $850 million put liability associated with the zero due 2031 as a short-term liability on the company's balance sheet," Nadesan said.

On Wednesday, the Omnicom 0% due 2031 had a yield-to-put of 10.1%, and the 0% due 2032 had a yield-to-put of 10.2%.

"OMC's two zero-coupon convertibles are trading at outsized yields to put," the analyst noted.

"In other words, the spread over Treasurys for these two bonds were 833 bps and 822 bps, respectively, hardly reflective of the company's current A/A3 credit rating."

He said the company should consider buying back at least part of these bonds before the put dates, as part of a refinancing plan that lengthens its debt duration.

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