Thrifty Drug owner readies debt offer to finance Payless purchase.

Panning for gold with which to buy the Payless Drug Stores chain, Los Angeles-based TCH Corp., the holding company for the Thrifty Drug store chain, plans to bring $600 million worth of new debt issues to market following this week's roadshow for potential investors.

The multi-city roadshow, hosted by lead underwriter Donaldson, Lufkin & Jenrette, is scheduled to end this Thursday, according to DLJ spokeswoman Jennifer Humphreys, who has helped launch the deal.

TCH plans to use the $600 million to acquire Wilsonville, Ore.-based Payless Drug Stores Northwest Inc. from Troy, Mich.-based Kmart Corp. The $1.1 billion deal -- $592 million in cash, $270 million in debt assumption and securities, plus roughly $230 million in TCH common stock -- was penned last December and, according to company officials, would create the largest drug store chain on the West Coast.

The participants hope to close the deal in early April.

Following the purchase, Thrifty Holdings Inc. -- the drug stores' operating company -- will become Thrifty Payless Inc., with Payless as its wholly owned subsidiary. Holding company TCH Corp. will be renamed Thrifty PayLess Holdings Inc.

Thrifty Payless Inc., according to the debt prospectus, will be controlled by Green Equity Investors L.P., an investor group led by Leonard Green & Partners L.P. Leonard Green will also serve as a director of the new operating company, as will two other LGP partners.

Green became a Thrifty's director in September 1992, when L.A.-based Pacific Enterprises -- parent of Southern California Gas -- sold the company to TCH, which was formed by Green Enterprises to acquire Thrifty.

Green's connection with Thrifty Payless, said one corporate bond trader who asked not to be identified, may "penalize" the company's financing due to a previous debt offering that Green structured for Kash n' Karry Food Stores Inc., a Tampa, Fla.-based convenience store retailer.

Kash n' Karry's operating performance, said the trader, has not been as good as expected, and the price for its 12.83 percent notes has dropped to about 90 percent of its original price.

The Thrifty Payless bonds will probably also face a pickier market than it would have earlier this year. According to Rich Handler, who heads the corporate bond trading desk for West L.A.-based investment bank Jefferies Group, investors are "much more selective than they were a month ago."

Handler based his opinion on the Federal Reserve Bank's recent boosting of short term interest rates which, in turn, increased mutual fund redemptions, leaving portfolio managers less money to invest.

On March 18, two of the nation's top debt rating agencies gave the upcoming Thrifty Payless debt offering a junk bond rating.

New York-based Standard & Poor's Corp. gave a B rating to the company's $200 million worth of senior debt notes due in 2003 and a B-minus to its $400 million in senior subordinated notes due 2004.

"Investment grade would be BBB or above," said S&P analyst Alison Lew. "This is called high-yield or junk, though I would prefer to call them high-yield or noninvestment grade."

Moody's Investors Service, also based in New York, rated the senior notes B2 and the senior subordinated notes a B3. "This is speculative grade -- clearly," noted analyst Brian Oak. "Baa3 and up are investment grades, Ba1 and below are considered speculative grade."

Although Oaks said he considers the Payless purchase "a strategic acquisition that makes sense in light of industry trends (ongoing consolidation) and the company's focus (third party prescriptions where size plays a big part)," he has concerns about the firm's high debt leverage.

"The debt-to-book capitalization will be in the 80 percentile on a pro forma basis," Oak said.

According to the prospectus, Thrifty will incur indebtedness of about $300 million over and above the amount of the notes under a bank credit agreement tied to the acquisition. This debt is secured by the company's assets.

Under the agreement, $250 million in term loans and about $50 million in revolving credits are expected to be drawn down after the acquisition is closed. The prospectus also notes that a $100 million standby letter of credit facility is expected to be used, though that was not included in the original $300 million estimate.

"There's modest interest coverage and their cash flow to interest expense is not high," said Moody's Oak. "If they (company officials) don't realize the cost savings expected from the merger, then it will be very thin."

Thrifty Payless officials are counting on merger-based savings of $50 million annually, beginning in 1995.

Corporate bond traders concurred that senior notes with comparable ratings yielded annual interest of roughly 10.25-11.25 percent right now. Senior subordinated notes were said to be yielding interest of about 10.75 to 12.25 percent.