"Schwarzman Denied Bargain as Junk Bond Rally Stymies Buybacks
June 3 (Bloomberg) -- Stephen Schwarzman, who pocketed $684 million in June 2007 by taking his buyout firm public before stocks plunged almost 60 percent, can’t get a bargain in the junk-bond market anymore.
The biggest high-yield rally ever is punishing the lowest- rated companies that may no longer be able to afford avoiding bankruptcy by exchanging or buying back debt at the lowest prices on record. The “cruel irony” of rising prices means the neediest businesses will have a harder time finding financing, Morgan Stanley analysts led by Jocelyn Chu in New York said in a May 15 report. That may lead to more defaults than anticipated.
Freescale Semiconductor Inc., part-owned by 62-year-old Schwarzman’s Blackstone Group LP, wiped away $1.9 billion of debt in March by giving investors an average of 32 cents on the dollar in loans. Since the bond exchange was announced March 4, the securities have tripled to as high as 54.1 cents on the dollar, curtailing the chipmaker’s ability to cut the rest of its $7.5 billion debt load.
Blackstone and its companies “were able to buy some stuff at really good prices,” Schwarzman, who built the world’s largest private-equity firm, said in a May 6 conference call with investors. “I wish we had bought back more, because those markets have really strengthened.”
Companies are exchanging bonds at a record pace, with 11 swaps of about $14 billion completed this year to take advantage of low prices, reduce debt loads and extend maturities, according to Edward Altman, creator of the Z-Score formula that calculates the likelihood of bankruptcy. There were 13 swaps last year, totaling about $30 billion.
“The upshot of the rally in CCC rated credit has made arguably the only financing market open to CCCs more costly,” Chu wrote in the report. “A rally may be positive for CCC bondholders, but not for issuers, especially in an environment where time passing and survival seem to be negatively correlated.”
Since March 9, bonds rated CCC and below, or at least seven steps less than investment grade, have jumped 64 percent to an eight-month high of 60 cents on the dollar, according to Merrill Lynch & Co. index data. The average price fell to a low of 32 cents on the dollar on Dec. 12 from about 80 cents at the end of May 2008.
Such bonds yield an average of 20.5 percent, or 18.4 percentage points more than Treasuries of similar maturity, according to Merrill’s U.S. High-Yield CCC and Lower Rated index. That’s down from 38 percent, or a spread of 36.7 percentage points, on March 9. A distressed security pays a yield of at least 10 percentage points over benchmark rates.
Buybacks of leveraged loans slowed in May to the fewest in eight months because of rising prices, according to Barclays Capital analysts led by Bradley Rogoff in New York.
Fewer debt exchanges “would increase the probability of bankruptcy” if they become less successful, Altman, a professor at New York University’s Stern School of Business, said in an interview. The lack of private Chapter 11 financing has made “it all the more important to do a distressed exchange to avoid bankruptcy,” he said.
Freescale said in April that it will exit the wireless- phone chip business, cut jobs and shut some manufacturing operations. The supplier to Motorola Inc., Ford Motor Co. and General Motors Corp. is trying to restructure and slash its debt as the recession reduces demand for cars and consumer electronics, two of the biggest markets for its products.
“From our point of view, the debt exchange was successful,” said Robert Hatley, a spokesman for Austin, Texas- based Freescale.
Toys “R” Us Inc., whose bonds almost doubled in price since March 31, must refinance more than half of its $5.4 billion of long-term debt before 2012, according to the Wayne, New Jersey-based retailer.
The largest U.S. toy-store chain, whose senior unsecured debt is rated Caa1 by Moody’s Investors Service and CCC+ by Standard & Poor’s, has reported total net income of about $136 million since it was bought by KKR & Co., Bain Capital LLC and Vornado Realty Trust for $6.6 billion in July 2005, 78 percent less than it posted in the previous 15 quarters. The company has $2.8 billion of cash and revolving credit available, according to Morgan Stanley.
“Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industries, expose us to interest-rate risk to the extent of our variable-rate debt and prevent us from meeting our obligations under the various debt instruments,” Toys “R” Us said in its most recent quarterly filing on March 31.
Toys “R” Us spokeswoman Kathleen Waugh declined to comment further.
At least 35 companies have offered to exchange or repurchase distressed bonds and loans this year, 83 percent of which were rated CCC+ or lower, compared with 15 all of last year and four in 2007, according to S&P.
The government promoted the surge in swaps through its American Recovery and Reinvestment Act, which became law in February, according to Chris Taggert, a CreditSights Inc. analyst in New York. The act allows companies to defer income from debt cancellation until 2014 and spread it over five years.
Harrah’s Entertainment Inc., the world’s biggest casino company, persuaded bondholders to exchange their securities at distressed prices twice since being taken private by Apollo Management LP and TPG Inc. for $17.1 billion 16 months ago, reducing the total by about $2.7 billion, according to CreditSights. In March, Las Vegas-based Harrah’s swapped $3.65 billion of new second-lien notes for $5.55 billion face value of unsecured bonds for as low as 40 cents on the dollar.
“It was a really fantastic period to be buying debt securities in our companies,” said Schwarzman, whose New York- based Blackstone owns a 4.9 percent equity stake in Harrah’s, which raised about $1.3 billion on May 27 by selling eight-year notes at a discount to yield 11.7 percent, Bloomberg data show.
Blackstone sold $4.75 billion in its initial public offering, the second by a buyout firm. In October 2007, the S&P 500 Index began its 57 percent descent from a record 1565.15 to a 12-year low of 676.53 in March 2009.
Schwarzman declined to comment further, according to Blackstone spokeswoman Heather Lucania.
$8.2 Billion Due
MGM Mirage, after offering about $2.6 billion in bonds and stock last month to repay debt due in 2009 and 2017, still faces about $8.2 billion in maturities in 2010 and 2011, according to the company’s most recent quarterly report, filed May 11 with the U.S. Securities and Exchange Commission. That’s about 58 percent of the total, excluding 2009 debt and notes due in 2017 that MGM plans to redeem.
To sell $1.5 billion of bonds, the Kirk Kerkorian- controlled casino company rated Caa2 by Moody’s had to secure the debt with assets of its Bellagio and Mirage hotels and pay yields as high as 11.6 percent.
The high-yield rally limited Las Vegas-based MGM Mirage’s financing options and prevented a “coercive” bond exchange, Chief Executive Officer Jim Murren said in a May 11 interview, before the sales.
Debt swaps “generally have worked best when there are big discounts, which we don’t have,” he said. “A lot of our near- term maturities are trading near par.”
Alan Feldman, an MGM spokesman, didn’t respond to telephone calls seeking further comment.
Corporate debt markets are improving as traders speculate the longest recession since the Great Depression may be easing after the U.S. government and Federal Reserve lent, spent or committed at least $12.8 trillion to the economy.
Confidence among consumers rose last month to the highest since September. The Institute for Supply Management said this week that its factory index, a measure of manufacturing in the U.S., rose to 42.8 from 40.1 in April. Purchases of new homes in the U.S. rose in April, the second increase in three months.
Junk-rated companies sold $24.5 billion of bonds last month, the most since May 2007, according to data compiled by Bloomberg. High-yield bonds and leveraged loans are rated below BBB- by S&P and less than Baa3 at Moody’s.
“The recovery in prices is helping people, not hurting them,” given that they can more easily swap debt for equity because of the stock rally, said Scott Minerd, who helps manage $30 billion in assets as chief investment officer at Guggenheim Partners Asset Management in Santa Monica, California.
‘Caught in Middle’
While CCC bondholders have been among the biggest winners, reaping 55 percent since March 9, the securities are still too distressed for many of the issuers to issue debt or obtain new lending from banks. The high-yield default rate will likely climb to 14.3 percent by April 2010 from 8.3 percent in May, according to S&P.
“They are caught in the middle,” Altman said.
Swaps and buybacks may not save a “troubled” company from bankruptcy, according to Morgan Stanley’s Chu. At least 46 percent of the 57 debt exchanges completed before 2008 were followed by a bankruptcy, Altman said. Almost 20 percent are still in business independently, while 30 percent were acquired, he said.
The market for high-yield debt began to fracture in July 2007, when rising defaults on subprime mortgages prompted investors to balk at financing the record wave of leveraged buyout deals.
At the time, bankers were trying to find investors for credit they provided in KKR’s 11.1 billion-pound ($18 billion) purchase of British drugstore chain Alliance Boots Ltd. Deutsche Bank AG, JPMorgan Chase & Co. and other banks were forced to delay selling 9 billion pounds of loans for the acquisition, which became one of the first deals frozen when credit markets seized up.
After beginning to recover in the first half of 2008, leveraged markets collapsed in September when Lehman Brothers Holdings Inc. filed for bankruptcy. Companies sold a monthly average of $2.4 billion of high-yield bonds from September through February, compared with $8.4 billion in the previous six months and $12.3 billion in 2007, Bloomberg data show.
Collateralized loan obligations, pools of below investment- grade borrowings sliced into securities of varying risk and return, fueled the buyout boom by purchasing about 60 percent of institutional leveraged loans before the market began to plummet.
U.S. leverage loan issuance this year totals $28.7 billion, compared with $143.8 billion a year earlier and $488.1 billion in the same period of 2007, according to Bloomberg data.
With the inability to borrow, companies refinanced by persuading battered investors to sell at distressed levels or swap for new securities with higher coupons and longer maturities. The rally is taking that option off the table, Chu wrote.
“It becomes less compelling when that excess goes out of the market,” said Martin Fridson, CEO of money manager Fridson Investment Advisors in New York.