[Upstart Level 3 Sells $2 Billion In Junk Bonds, Renews Worry]
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
April 24, 1998
The frenzy in the junk-bond market reached a new pitch when upstart telecommunications company Level 3 Communications Inc. sold $2 billion in junk bonds, equaling the largest corporate junk-bond deal so far in the 1990s.
The deal underscored investor confidence in management of the fledgling company, based in Omaha, Neb. But the sale renewed worries among some investors that the junk-bond market is getting overheated.
Junk, or high-yield bonds, are rated below investment grade because they are riskier than higher-rated bonds. As a result, they carry a higher yield than investment-grade bonds.
It is this high yield that has attracted investors. As of a week ago, $53.7 billion of junk bonds had been sold this year, almost double the $27.1 billion of the comparable period in 1997. Level 3 sold the junk bonds to raise money to build a fiber-optic network for telephone and other communications services in the U.S. and Europe. Level 3 was spun off earlier this month from Peter Kiewit Sons, a closely held construction company in Omaha.
The Level 3 10-year notes were sold at a yield of 9.19%, or 3.5 percentage points above 10-year Treasurys. They were rated single-B by Standard & Poor's, and single-B-3 by Moody's Investors Service. The securities were sold under Rule 144a private-placement regulations to institutional investors. Underwriter Salomon Smith Barney was unavailable to comment.
The deal, originally sized at $1.5 billion, was boosted to $2 billion Wednesday, thanks to heavy investor interest, equaling the largest deal so far of the 1990s, according to CommScan LLC. The deal dwarfed the $186 million average size of new issues this year.
"It was a dramatic event," said Martin Fridson, Merrill Lynch's chief high-yield strategist.
Investors were unsparing in their praise for Level 3's management. "I love these guys," said Jerry Paul of Invesco Funds Group, who bought Level 3 bonds Thursday. "It wasn't unduly cheap, but Level 3 isn't your typical telecom start-up; it has over $3 billion in assets."
The excitement over the Level 3 deal reflects the increasing interest in junk bonds as alternatives to the near-record-low yields on Treasurys, and near-record-high prices of stocks. As of April 15, almost $9 billion had flowed into junk-bond mutual funds this year, and the year-end total could top $33 billion, according to Merrill Lynch. A record $22 billion flowed into high-yield mutual funds last year, topping 1996's previous record of $15.5 billion.
Other junk-bond buyers are also multiplying, including insurance companies, pension funds and a new group of buyers: European investors. The number of European junk-bond issuers is expanding, but the investor universe is growing at a faster pace and, in its search for a place to put its money, is heading to the U.S.
The surging demand has sent junk-bond prices climbing, and their yields, which move in the opposite direction, falling. The spread, or difference in yield, between junk bonds and safe Treasury securities stands at 3.26 percentage points, up from 3.17 earlier this month, but not too far from the record low of 3.03 reached Oct. 16, according to Bear, Stearns & Co.
The figure is well below the 4.5 percentage-point average during the 1990s, suggesting that investors are demanding less reward for accepting the risk of buying lower-rated bonds.
Once dominated by companies that had run into hard times, or by those laden with debt as a result of leveraged buyouts, the junk-bond market is increasingly populated by young, expanding companies with little track record but much promise.
Often, these companies are in growing industries. About 31% of new high-yield issues last year came from the communications industry, up from 6% in 1992.
Still, some analysts couldn't help drawing parallels between the Level 3 deal and the massive $4.1 billion junk-bond deal in 1989 by RJR Holdings Capital, which later became RJR Nabisco Holdings Corp. That deal effectively marked a top in the then white-hot junk-bond market. Level 3 has no earnings or track record, and while its management team, led by Chief Executive Officer James Crowe, built and then sold local-exchange carrier MFS Communications for a large profit, some analysts remain cautious.
"Everybody in the high-yield market likes the communications industry because they've made a lot of money in it, but a lot of these guys barely have revenues," Robert Kricheff, Credit Suisse First Boston's head of high-yield research, said. "They've got good equity value and assets, but most of us in the junk-bond market are not engineers who understand the changes in the industry, and that's a concern."
Mr. Fridson added, "In some ways it makes me think of the RJR deal, which was the beginning of the end, in that it takes the whole thing to a new level, but that's too neat an analogy."
Indeed, while default rates are rising, they remain at historically low levels. In the year ended March 31, defaults amounted to 2.2% of outstanding junk bonds, according to Moody's, up from 1.8% in 1997, but well under the 3.4% average rate during the 28 years ended Jan. 1 of this year. By contrast, defaults stood at 3.7% in 1988 and 6% in 1989, respectively. |
