Bonds Take a Back Seat to Convertibles: Rates of Return
York, March 21 (Bloomberg) -- When John Brittain,
at Nextel Communications Inc., was considering how to
the company's expansion in January, he was faced with the
of selling stock or debt. He chose both.
the Reston, Virginia-based wireless phone company's
up four-fold in the past year, and the high-yield bond
in the doldrums, Brittain opted to sell convertible bonds
a second time since June.
just a day's notice, Nextel issued $1 billion of
notes with a 5 1/4 percent interest rate -- more than
percentage points lower than the yield it paid on its most
junk bond sale in November.
made absolute sense,'' said Brittain.
isn't the only borrower branching into the $200
convertible debt market. Primus Telecommunications Group
Level 3 Communications Inc. and Pinnacle Holdings Inc. also
them, putting sales on track for an all-time high this year.
62 borrowers -- predominantly risky or unrated
-- raised $21.7 billion in the convertible market year-
a record for that period, according to Lehman Brothers
Based on the pace of sales so far, the years' total
reach $50 billion, overtaking last year's record $44.2
of offerings, analysts said.
bonds are being ``bypassed by some companies'' in favor
the convertible market, especially by fast-growing telecom and
companies, said Bob Kricheff, a managing director and
bond analyst at Credit Suisse First Boston. Companies
already raised some 40 percent more money in the convertible
market this year than they did selling junk bonds.
of the appeal in selling convertibles lies in the lower
rates a company achieves, in exchange for giving up some
its shares. At the same time, the potential for big gains in an
shares makes investors ``more forgiving,'' allowing
that might otherwise be shut out of the high-yield
to raise funds, said Ravi Suria, head of the convertibles
group at Lehman Brothers.
a company's shares keep rising, the bonds -- which
are being bought by high-yield mutual fund managers
do well. If the shares fall, losses are cushioned by semi-
interest payments and the promise that the securities will
repaid at face value at maturity.
rosy outlook for convertibles stands in sharp contrast to
junk bond market, which is wallowing for a third straight year
as the Nasdaq Composite Index -- home to many of the telecom,
and high-tech companies that are selling convertible
-- has reached a record. The stock index is up more than 14
so far this year.
bond prices fell 8 percent in the 12 months ended in
and returns to investors were just 0.97 percent
interest, according to a Merrill Lynch & Co. index. That
with returns of about 44.1 percent on convertible notes
in the period, according to Warburg Dillon Read
stock market's stunning gains have lured investors from
bonds -- prompting withdrawals of almost $3 billion from high-
mutual funds the past 15 weeks. Rising interest rates and
near their highest level since 1991 also have made it
costly for many borrowers to raise funds, and discouraged
from taking a chance on riskier companies.
good performance is in the equity market, not in high
right now,'' said Kevin Mathews, who helps manage $3 billion
junk bonds at Pilgrim America Group in Phoenix.
to interest-rate concerns, the Federal Reserve today
its target for overnight bank lending in the fifth quarter-
move since June. The rate is now 6 percent, the highest
in almost five years.
borrowers dissuaded from selling debt by the current
Mandalay Resort Group, the fourth-largest U.S. casino
shelved a bond sale this month rather than pay fat
Others, including Colo.com and XM Satellite Radio Holdings
included equity warrants with already hefty yields to drum
convertible market is another story.
Virginia-based Primus, which provides voice, data and
services entered the convertible market for the first
in February, raising $300 million with notes that readily
whose stock is up almost four-fold the past year,
seven-year convertible notes with a 5 3/4 percent yield --
half the yield on its outstanding high-yield notes.
looked at all the different options -- and with our
price rising, a convertible note sale seemed to be the best
said Neil Hazard, executive vice president and chief
officer. And the high-yield market, where four-year old
had borrowed before, ``wasn't doing so well,'' he said.
recent borrowers include Broomfield, Colorado-based
3, which is building an optical fiber phone and data network
the U.S. and Europe, and Sarasota, Florida-based Pinnacle,
owns and manages wireless communications towers.
be sure, the appeal of convertible debt is contingent on
gains in the stock market, which aren't assured. The
index, while up for the year, has slipped almost 9 percent
its record 5133 reached earlier this month. And there are
so many shares a company is willing to offer.
now though, lower-rated companies such as Redback
Inc. aren't letting the chance go by to raise money at a
cost than they'd face selling junk bonds. The company -- a
of equipment to ease data traffic on high-speed online
whose shares have surged 87 percent this year -- is
a $500 million sale.
cost advantage for a lot of companies is a no-
said Sri Nadesan, director of convertible securities at
Dillon Read. ``It's very hard for a chief financial