This is from Barron's on Amazons Bonds:
<<Amazon.com once again captured the market's fancy last week. With little effort, the big Internet retailer sold $1.25 billion of 4.75% convertible bonds due in 2009.
Demand was so strong that the deal was more than doubled from its starting point of $500 million. And Amazon officials didn't have to trudge around visiting investors to market the deal. Lead underwriter Morgan Stanley Dean Witter launched the offering Thursday morning and priced it by nightfall.
Initially, the deal traded well. The converts traded up to 105 before they were even priced. But enthusiasm sagged after the offering's size ballooned. By Friday's close, the bonds fell to 98 3/4 and Amazon's stock fell 5 15/16 points to 116 15/16. The shares suffered both from the potential dilution posed by the converts and from pressure exerted by hedge funds that buy convertible bonds and short the issuer's stock to offset their risk.
Why did investors pounce on this deal? Sandra Durn, a portfolio manager at Nicholas-Applegate, liked the fact that the bonds would participate in 85% of Amazon's upward price move but suffer only 40% of any downside. "For me, this is the perfect way to play the Internet," says Durn.
Then there's the frenzy surrounding the stock. Reports circulated that Amazon officials have been telling analysts they believe the stock's price will rise so fast they'll be able to call the bonds and force investors to convert into stock within a year. Now, that can only occur if the stock rises to $234.08 -- a 90% climb from Thursday's close of $122.875.
"They don't think they're going to make the coupon payment for too long," says Ravi Malik, a portfolio manager at Froley-Revy, an institutional bond-fund manager.
An Amazon spokesman, however, said company officials did not discuss the bond's potential conversion. "That's cockamamie," he said. "We never talk about our stock price."
But now that the excitement is over, consider the following: Many of the investors in the world of convertible bonds are hedge funds that buy the bond and short the stock. So in general, they aren't concerned with the stock price or the company's credit quality, just the volatility of the stock. As a result, their participation can skew the market's supply/demand dynamics.
"This is the only market where a triple-C-rated company can raise money with a coupon under 5% and get rewarded for its stock's volatility," notes Neil Feinberg, a director at MacKay Shields. In addition, many investors will buy the bonds because they get measured against an index in which Amazon's converts will likely be included. These investors aren't focused on the fact that the company has yet to turn a profit. Indeed, it seems as if Amazon will have to pay the coupon from the proceeds of the bond offering.
Junk-bond investors, on the other hand, are generally more aware of credit concerns. And while the stock has skyrocketed over the past year, the junk bond Amazon sold last spring trades below par. The zero-coupon bond trades around 65.5, and accreted value is 66.0885.
The convertible bond market has become notorious for attracting red-hot industries, with volatile stocks, that are looking for cash. The problem: The stocks seem to peak soon after they visit the convert market. Oil-service companies sold a slew of convertible bonds before the price of oil took a dive and sent the stocks spiraling down. Ditto for health care. Coincidence? Maybe. But you can be sure that a batch of Internet companies will hit the convertible bond market in the next few months. Then watch out.>> |
