Thursday, October 11, 2018
A recent article in Bloomberg highlights a potential threat to the bond market. Recent years have seen a number of high-priced acquisitions funded by debt. As a result, many of these companies have dramatically increased leverage as measured by Debt/EBITDA. This has caused a drop in credit ratings, with $2.47 trillion worth of debt now rated as BBB, more than three times the 2008 level of BBB debt. Even though many of the deals are funded through debt, a common assumption is that synergies and the improved cash flow would allow the company to quickly pay down debt. But a hiccup in the economy or synergies not materializing could limit debt pay down. In the last three recessions, from 7 to 15 percent of investment grades bonds were downgraded to junk status. Given the higher amount of debt with lower credit ratings, a recession in the next couple of years could push a massive amount of corporate debt into junk territory.
It appears that Sears, once the world’s largest retailer, may file for bankruptcy as soon as this weekend. One alternative being explored is a Section 363, or stalking horse, filing. In a Section 363 filing, the company would sell some of its assets, but the sale would still have to be approved by the bankruptcy court. For example, CEO Eddie Lampert has already offered $480 million for the company’s Kenmore appliance and home improvement division. If successful, the company would exit the bankruptcy with fewer assets, but less debt as well.
Wednesday, October 10, 2018
As Hurricane Michael hits the Gulf Coast, pension funds, endowments, and other large investors are getting nervous. About $15.7 billion wort of CAT bonds are exposed to a Florida hurricane. Large investors have been drawn into CAT bonds because of higher potential returns and the diversification these bonds can provide. The total CAT bond market is currently at $30 billion. For a major catastrophe, an insurance company typically cover the first part of its loss, then relies on reinsurance or securities to help cover the rest. If the trigger is hit on a CAT bond, often the bond is cancelled, meaning the bondholder receives no further coupon payments and no par value upon redemption.
Tuesday, October 9, 2018
Papa John's stock has been battered this year after comments made by founder John Schnatter on a conference call. Schnatter resigned as chairman in July, but still owns about 30 percent of the company's stock. In a nod to the bidding wars that can occur in a takeover battle, the stock jumped nearly 8 percent today when it was announced that Trian Fund Management is considering a bid to buy the company and take it private.
As we noted in the textbook, an increase in interest rates will decrease the price of a bond. And recently, interest rates have been rising. U.S. high-grade debt is down 2.53 percent this year and the 10-year U.S. Treasury bond has lost 3.23 percent this year as well. To give you an idea of the magnitude of losses worldwide, the Barclays Multiverse Index, which includes investment grade and high yield bonds from around the globe, has lost about $916 billion in market value this year.
One thing to keep in mind with present value calculations, if you calculate the present value using real cash flows and the real interest rate or nominal cash flows and the nominal interest rate, the present value will be unaffected. This is true for capital budgeting as well So where can you get expectations of future inflation? One place is the New York Federal Reserve, which publishes microeconomic data, including expectations of consumer inflation. We should warn you, these are expectations, and like any expectations, are not exact.
Wednesday, October 3, 2018
In order to finance the $39 billion acquisition of Sky Plc, Comcast sold $27 billion worth of unsecured bonds. This is the second largest bond offering of the year and the fourth largest all-time. The company sold 12 different bonds, ranging from a 2-year maturity to a 40-year maturity in the offer. Investors jumped at the bonds, putting in orders for $88 billion, which allowed Comcast to issue the 40-year maturity at a yield spread of 1.75 percent above Treasuries. The bond issue will increase Comcast's leverage from 2.2 times EBITDA to 3.6 times EBITDA. The bonds are rated A with a negative outlook, which means there may be a downgrade in the future.