Auto-parts maker Johnson Controls Inc. (JCI) is exchanging its 6.5% convertible senior notes due 2012 and its equity units in the form of corporate units to reduce the amount of its outstanding debt and related ongoing interest expense.

As of Jun 30, 2009, Johnson Control had approximately $4.8 billion of outstanding debt, including $450 million of equity units.

Johnson Controls will exchange all of its convertible notes for 89.3855 common shares plus $120 in cash and accrued and unpaid interest per $1,000 of principal notes. The company originally issued $402.5 million of convertible notes.

The company will also exchange up to 8.55 million corporate units, or 95% of its outstanding equity units, for 4.8579 common shares, $6.50 in cash and accrued and unpaid interest on the 11.5% notes due 2042 that make up part of the units.

Soon after Johnson Controls’ second-quarter results in July, Standard & Poor’s Ratings Services took the company off watch for downgrade. Fitch also removed the Wisconsin-based company from Rating Watch Negative and affirmed a Negative rating.

The agencies stated that challenges in Johnson Controls’ Automotive Experience business and weak demand in the non-residential construction markets through 2010 corroborates the negative outlook. This is worsened by high leverage and margin pressure related to lower sales volumes across the major business segments. Low production volumes in Europe and North America and industry restructuring are significant concerns for the company.

A weak construction sector also affects Johnson Control’s Building Efficiency business. The company’s near-term results in the segment are to be pressured by weak non-residential markets in North America and Europe through 2009 and 2010.

However, Johnson Controls has an edge over its competitors, such as Magna International (MGA) and Hastings Manufacturing Company, in being more diverse. Johnson Control’s exposure to the three auto giants – General Motors, Ford Motor (F) and Chrysler – is lower.

The Automotive Experience segment forms less than a third of its profits. Three quarters of sales in the battery business are to the aftermarket, which provides some stability. We expect margins in the segment to benefit from a lower cost structure and the eventual completion of a lead smelter in 2010, which should reduce production costs.

We maintain our Neutral recommendation on the stock with a target price of $27.00.

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