A great post from AOL about the junk bonds...............
Subject: Re: Bond Stuff
Date: Wed, Jun 3, 1998 18:13 EDT
From: BMYNARD
Message-id: <1998060322131500.SAA20904@ladder01.news.aol.com>
Hi, I have not read the prospectus of the Amazon bond issue but I think there is a considerable amount of misunderstanding of the nature of the bond issue.
1) Non sec registered bonds can be sold in the US , to Qualified Investment Buyers (QIB's).These are essentially institutions.
2) The nature of the call feature as described in 2003 is penal not beneficial. Assuming that is the only call feature it is unlikely to be exercised. Let me explain by example. Amazon issue zero coupon ie discounted bonds at 10% for 10 years. Assume the similar maturity US Government bond yields 5%. That means Amazon is borrowing at 500 bp more than the US govt , that is the so called spread or risk premium. If in 2003 Amazon wishes to call the bond
and assuming rates not change they will have to bid the yield on the then five year US govt plus 50 bp whichn would be 5.50% . As bond price movement is inverse to yield that is a repurchase price of above 100% ( think about that , good for bond investors not the issuer). For Amazon to do this they would most likely have to have a credit rating of AA or better to achieve lower refinancing . Even Intel is not AA ( I think) , the statistical chance of
a Caa going to a AA rating in five years is extremely small.
Therefore the likelihood of the call being exercised unless yields rise substantially is very small. ie US Treasury prices and call price falling.
In fact I would suggest this is a very expensive debt offering for Amazon , not in terms of the loan it replaces but in the nature of interest compounding that zero bonds exhibit. Frankly it would scare me that they are borrowing at 500 bp over US treasuries in a form reserved for companies that are lacking cash flow ,to pay for future losses !. This is all very reminicent of the late 80's and the similar Payment In Kind bonds issued that led to a
lot of bankruptcies as the economy soured and debts built up to unsustainable levels. Dont be fooled by any comments about not having to worry about the debt build up as it is a zero etc . This is a potential time bomb. Amazon would much rather pay regular coupons if they could afford it. Consider the following.
1) Equity ranks below debt , if company gets in trouble equity is wiped out first . With few tangible assets Amazon equity is particularily vulnurable to this.
2) If you borrowed $250 million today and had to pay back $500 million in 10 years you had better use that money wisely as a rating of Caa implies future borrowing will be hard to come by, especially as you have no assets to offer as collateral. In fact you are in a race to earn more than 10% per year on that money to be able to pay it off. This is especially true in a low inflationary environment. This borrowing assumes a sigificant improvement of
the balance sheet over the next few years.
To sum up , if there are other terms to the bond issue that I am unaware of that may negate some of my points. However, I think the borrowing is a sign of weakness not strength, after 15 years in the bond market alarm bells are ringing all around me.
Regards
Brian Mynard
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