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