Fixed Income . Corporate Bond Issuance and Trading

Question

1. As a member of the BofA/Merrill Lynch cor- 100 porate bond origination team, you are working on an upcoming transaction on behalf of Western Digital Corp. (Nasdaq: WDC) which is planning a massive bond offering to fund the acquisition of SanDisk Corp. (Nasdaq: SNDK). You are in charge of all the fixed-income analysis and report directly to the lead banker. A lot is on the line for your company because this deal might become the largest bond offering in 2016 so far. Here is recent press coverage of the announcement of the bond offering:

Western Digital Readies $5.6B Bond Offering Backing SanDisk Buy

Western Digital this morning launched off the shadow calendar its SanDisk acquisition bond financing, comprising $1.5 billion of seven-year (non-call three) secured notes and $4.1 billion of eight-year (non-call three) senior notes, according to sources. Roadshows are scheduled to run Monday, March 21 through Monday, March 28, with pricing to follow via a Bank of America–led bookrunner team, the sources added.

While first call premiums have not been outlined for the two series, take note that while par plus 75% coupon to balance the short schedule is most typical, an issuer-friendly arrangement at par plus 50% coupon has become more acceptable over the past year. Beyond that, market sources relay that the equity-clawback feature on both tranches is most typical, as three-year for up to 35% of the issue, at par plus coupon, and the change-of-control call provisions are also regular-way, at 101% of par.

Additional bookrunners on the long-awaited effort are J.P. Morgan, Credit Suisse, RBC, and HSBC. Proceeds, along with those from a TLA, TLB, and an RC draw, will be used to back the $19 billion acquisition of the rival storage-technology company, and issuance is under Rule 144A for life.

As reported, the company has guided the $4.2 billion U.S. dollar TLB, and $550 million- equivalent, euro-denominated TLB at L/E+450–475, with a 0.75% floor and OID of 98.5. The seven-year, covenant-lite term debt will include 12 months of 101 soft call protection, and at current guidance the term loan would yield roughly 5.64–5.9% to maturity.

Take note that the same bank line up is arranging the loans but J.P. Morgan is the left lead. A planned $3 billion, five-year A term loan has been increased to $3.75 billion, with pricing set at L+200. Western Digital also plans to draw down a portion of its $1 billion, five-year revolver at closing.

Issuer ratings have firmed at BB+/Ba1/BB+. The secured debt is rated BBB–/Ba1/BBB–, with a 2L (lower end of substantial, 80–90%) recovery rating from S&P’s. The unsecured debt is rated BB+/Ba2/BB+, with a 4L (lower end of average 40–50%) recovery rating.

Irvine, Calif.–based Western Digital makes hard disk drives, solid state drives, and cloud- network storage solutions, with a client focus on set-top boxes, printers, in-car navigation devices, and other general consumer electronics. Milpitas, Calif.-based SanDisk makes solid- state drives and other storage solutions with a client focus on computers, tablets, phones, and wearables. (March 18, 2016)

You might also want to refer to the attached materials on interest rates and high-yield bonds in 2016.

1. Analyze the terms of the Western Digital offering. Here is an extract of the term sheet: 

1. How well has WDC been doing? What is the financing for?
2. What exactly is on offer? How do the tranches differ?
3. Are the bonds callable? If so, when and why?
4. What other debt is WDC taking on and how is it structured? 
5. Using the attached information or any other data, whose source you would have to carefully document, price the debt and complete the above term sheet.
6. How is corporate debt priced? Propose a methodology.
7. What yields would you propose for the two series? Carefully explain to the lead banker your reasoning and document your analysis. 
8. Determine the series’ coupon and price to fill in all the remaining fields above.
9. Research the issue and try to find out what happened. Did the final offering differ from the initial announcement and, if so, what happened? How did the pricing vary from your analysis and why?
10. In order to secure the lead in the deal, your company has agreed to offer liquidity services for up to 12 months. In essence, BAML’s corporate-bond traders stand ready to make markets in the WDC series, i.e., quote firm bid-ask prices at which they stand ready to buy or sell typical blocks of $1m to $2m. In order to do so, they have to keep significant inventory in the notes.
11. When traders in corporations have to hold (long) positions for inventory or prop(rietary)- trading purposes they typically take the offsetting position in maturity-matched US Treasuries. Why? What is the purpose of this strategy and what is their residual position?
12. What are the risks and benefits of this strategy?
13. How would your colleagues at BAML fund the necessary inventory to provide the promised liquidity services to investors and the issuer and at the same time imple- ment the long-short strategy? Describe two different implementations and recom- mend your favorite one. 

Answer 1

Western Digital Corporate Bond Case (Short Answer)

1. Company situation & purpose of financing

Western Digital (WDC) is a BB+/Ba1 rated storage technology company taking on significant leverage to fund its $19B acquisition of SanDisk. The bond issuance is part of a broader financing package including term loans and a revolver. The goal is to fund the acquisition and maintain liquidity.

2. What is being issued?

WDC is issuing two bond tranches:

1. $1.5B secured 7-year notes (non-call 3)
2. $4.1B senior unsecured 8-year notes (non-call 3)

Key difference:

1. Secured bonds = backed by assets, lower risk, lower yield
2. Unsecured bonds = no collateral, higher risk, higher yield

3. Call features

Both tranches are non-call for 3 years, meaning the issuer cannot redeem early during that period. After that, they become callable, allowing refinancing if interest rates fall.

4. Other debt in the structure

WDC also raises bank financing:

1. $4.2B Term Loan B (secured, higher yield)
2. $3.75B Term Loan A
3. $550M euro term loan
4. $1B revolver draw

Capital structure priority:

Revolver → Term Loans → Secured bonds → Unsecured bonds

5. How corporate bonds are priced

Corporate bonds are priced as:

Yield = Treasury rate + Credit spread

Spread depends on:

1. Credit rating (BB+)
2. leverage after acquisition
3. industry risk
4. secured vs unsecured structure

6. Estimated pricing (2016 market)

1. Secured 7-year notes: ~5.5%–6.0% yield
2. Unsecured 8-year notes: ~6.25%–6.75% yield

Secured bonds price tighter due to collateral and higher recovery value.

7. Hedging strategy (Treasury offset)

Banks hold bond inventory but hedge interest rate risk using maturity-matched US Treasuries.

1. Long corporate bond
2. Offset with Treasury position

This removes interest rate risk and isolates credit risk.

8. Inventory funding & trading strategy

Banks fund bond inventory using:

1. Repo financing (preferred) – borrow cash against bonds
2. Balance sheet funding – bank capital allocation

Best approach: repo + Treasury hedging because it is cheaper and scalable.

9. Overall summary

WDC is issuing high-yield debt to fund a large acquisition. The bonds are structured with different risk levels, callable features, and layered with bank loans. Pricing reflects credit risk above Treasuries, and dealers hedge rate exposure using matched Treasury positions while funding inventory through repo markets.