THE BOOTS CASE
In October 2001, Boots Co. Plc announced that it had sold its entire equity holdings of £1.7 billion (75 percent of total pension assets) and invested in long-dated AAA sterling bonds with a weighted average maturity of 30 years. Initially 25 percent inflation linked, in 2002 this amount was swapped up to 50 percent. The pension fund measured £2.3 billion in assets, or roughly 45 percent as large as the company’s total asset base and was not considered to be a mature pension, as half of its members were active employees.
The stock price was unaffected by the initial announcement (but weakened by half-year results) but appears to have reacted favorably to the corresponding announcement of share repurchases.
The agencies noted that though not the impetus for the change, with the recent introduction of Financial Reporting Standard (FRS) 17, by switching to 100 percent fixed income, there would be less of an accounting shock. The rating agencies made no change to the credit rating (A+/A1), but unfortunately, the share repurchase and subsequent leverage profile seem to have been significantly undersized. Initially, £300 million, the program was later upsized to £700 million.
Though application of the Fischer Black plan (Table 12.2) would suggest £1.7 billion of new debt capacity after tax and suggest increasing leverage from about 10 percent to 30 percent of enterprise value, the buyback program was funded from operating cash flow and leverage did not change appreciably. ...