>Red Herring
February 3 1999
Fueled by e-commerce mania, normally staid institutional investors vied frantically to get in on Amazon.com's (AMZN) recent junk bond offering, despite unattractive terms and a poor credit rating.
In response to this demand, Amazon increased its offering size from an initial $500 million to a monstrous $1.25 billion.
Keith Benjamin, a managing director with BancBoston Robertson Stephens, attributes the frenzied investor response to the lack of Internet deals in the convertible bond market. "My sense is that there isn't a lot of supply at the moment."
He adds, "If you're a convertible investor, there aren't that many high-flying convertible growths."
BOND LINGO
What are these investors actually buying? Amazon's debt offering consists of 10-year bonds with a coupon, or interest rate, of 4.75 percent. The bonds are convertible to stock at $156.05 a share. This is more expensive and, therefore, priced at a premium to the current share price of $125.75 (as of market close on Wednesday, February 3).
According to Moody's Investors Service, Amazon's bond offering has a credit rating of Caa3. This rating represents the company's projected capability to pay the interest and principal on the bonds. Since its rating is below BBB, Amazon's bonds are considered below investment grade; these types of bonds are also known as high-yield or "junk" bonds.
A high-yield bond usually carries a high interest rate to compensate the investor for the risk involved. Generally, the weaker a company's financial condition, the more it must pay to borrow money.
IGNORING RISK
Reflecting the Internet frenzy and the current disregard for profitability, another Wall Street rule is being ignored.
Amazon is raising this debt to finance the building of physical infrastructure, such as distribution centers. Although profitability is still elusive and more debt further weakens the company's tenuous balance sheet, the company is getting cheap money. Its bonds will not cost the company much in the way of interest, and its convertible price currently values Amazon shares well above the current trading price.
Yet even with unattractive terms, institutional investors still demanded more bonds than the company supplied. The growth potential for a flagship Internet retailer appears to be the key reason for this disregard for risk.
As Mr. Benjamin maintains, the potential for a "phenomenal future" for Amazon is more important to investors than a weak balance sheet.
March 13 2001
NEW YORK, March 13 (Reuters) - Only in a stock market as depressed as the current one could a year-to-date return through Monday of negative 5.41 percent look pretty good.
That is what funds investing in convertible securities have returned, fund information service Morningstar Inc. said. But during the same period, the Standard & Poor's 500 index has dropped 10.6 percent.
This shows why some portfolio managers and analysts favor convertibles as a way to mute stock market risk.
"For the most part, convertibles are performing as advertised," said Ted Everett, who manages the $840 million Oppenheimer Convertible Securities Fund, whose Class A shares are down just 1.96 percent this year. "It's a way to have one foot in the equity market without fully committing yourself."
A convertible is a hybrid security that usually offers current income and can be converted into company stock. It offers a lower yield than a regular corporate bond because of the conversion feature.
Portfolio managers say convertibles should provide about 70 to 80 percent of the upside of stocks and suffer only 50 to 60 percent of the downside, cushioned by their interest payments.
That is certainly been the case this year. In February, for example, Salomon Smith Barney's convertible securities index fell 6.82 percent, while the underlying stocks fell 12.74 percent. Convertibles, therefore, fell 53.5 percent as much.
"Clearly the convertible market has delivered better risk- adjusted returns than stocks," said Venu Krishna, vice president and convertible securities analyst for Salomon.
BUSTED CONVERTIBLES LESS SENSITIVE TO STOCKS
The typical convertible "conversion premium," or the percentage by which an underlying stock must rise to make converting worthwhile, rose in January and February to 44 percent from 36.6 percent, Salomon said.
Meanwhile, it said, the typical convertible yield has stayed at 5.6 percent. Investment-grade and junk corporate bonds, in contrast, now yield about 6.6 and 12.1 percent, respectively, according to Merrill Lynch & Co.
The plunge in stocks also triggered a surge in "busted" convertibles. These occur when a stock falls so far below the conversion price an investor can forget about converting soon. That causes the convertible to act more like a bond.
"If you do your credit homework, you could be clipping a high coupon and getting a high yield to maturity and get a discounted call option should the stock eventually appreciate," said Eric Wong, vice president and portfolio manager for Trust Company of the West in Los Angeles.
Some busted convertibles carry plenty of risk. For example, Lehman Brothers Inc. analyst Ravi Suria has since last June urged investors to sell the 4.75 percent notes maturing in 2009 of Internet retailer Amazon.com Inc. (NASDAQ:AMZN).
Those notes are being bid at 39 cents on the dollar. Meanwhile, the stock, which traded late Tuesday at $10-11/16, would have to rise 730 percent to reach the $78.03 conversion price. The effect: Amazon.com's shares must rise 187 percent for the convertible's price to equal its equity value.
Other busted convertibles have higher credit ratings than Amazon.com's "Caa3" rating from Moody's Investors Service and "CCC-plus" from Standard & Poor's. Krishna recommends the 20- year bonds of Sanmina Corp. (NASDAQ:SANM), a San Jose, Calif.-based electronics component maker. They recently traded at 37 cents on the dollar, with a yield-to-put -- the date when investors may return the bonds to Sanmina -- of 9 percent.
Yields like that look good when equity markets look shaky.
"A lot of bonds have a yield to maturity of 11 or 12 or 13 percent and, over time, that could look pretty good relative to the equity market," said Everett.
Stocks have returned an average 11 percent a year since 1926, according to the Vanguard Group, the No. 2 U.S. mutual fund company.
TREAD CAREFULLY
As always, analysts urge most investors to avoid the do-it- yourself approach to convertibles, which are even more arcane than regular corporate bonds.
Most investors should buy convertibles through mutual funds, they say, and should not view them, like cash, as a pure safe haven from stocks. Still, they say investors may buy them even if they believe stocks have nowhere to go but up.
"It is very difficult to call a bottom," said Krishna. "This year, more of the value in convertibles will be driven from interest rate cuts and narrowing credit spreads, rather than any boost we may see from corporate earnings growth."
Everett, for his part, on Monday sold notes of Norwood, Mass.-based chipmaker Analog Devices Inc. (NYSE:ADI), which he said fell less than 10 percent in a period Analog stock slid by more than half.
"(The bonds) had done too good of a job on the downside," he said. "It's great to play defense, but at some point you have to play offense," Everett added.
He still owns bonds of two other chipmakers that last week cut earnings estimates, San Jose-based Cypress Semiconductor Corp. (NYSE:CY) and Camarillo, Calif.-based Vitesse Semiconductor Corp. (NASDAQ:VTSS). Their share prices are volatile, adding to the potential that conversion will become worthwhile, he added. |
