Investors enticed by hybrid bonds
By Sara Silver
Associated Press
NEW YORK — Who would invest in a telecommunications company that has lost $22 billion and announced 30,000 layoffs so far this year?
Lots of investors, it turns out, who were so hot to put money into Nortel Networks Corp. that the company was able to raise a greater-than-expected $1.8 billion in new funds.
Nortel, the global leader in optical Internet and wireless products, is the latest technology company to find financing in a tight market by selling convertible bonds, a hybrid security that pays interest until the stock price rises, when it can be converted into shares.
Nortel's completion of its expanded offering on Wednesday follows August placements of $1.5 billion in covertible bonds by Sprint Corp. and a $1.75 billion placement by the ailing Lucent Technologies Inc., whose convertible preferred stock pays dividends rather than interest.
Convertible securities let battered telecommunications companies find new cash while listless stock markets prevent them from issuing new shares and while lowered credit ratings make it expensive to issue straight debt.
"Nortel and Lucent are still dominant players in the telecommunications equipment industry, and if people feel that there's any future to telecom equipment, then these companies will be a part of it," said Ted Everett, portfolio manager of the $770 million Oppenheimer Convertible Securities Fund, which bought both issues.
"I'm always on the lookout for companies in industries trading at depressed prices that have an opportunity to recover in their business fundamentals as well as in their stock."
Keen interest from institutional investors and hedge funds has led to a record $54.5 billion of convertible issues so far this year, up from $36.3 billion at the same time last year, according to Diane Vazza, head of global fixed income research at Standard & Poors.
Driving the increase are established companies tapping into a market formerly used by companies whose debt ratings are so low that they can only sell high-yield or "junk" bonds, Vazza said.
Telecommunications giant Verizon Communications Inc. made the largest offering in May, selling $3 billion in convertible zero-coupon notes, which pay no interest, but offer a yield to maturity of 3 percent.
Convertible bonds make a lot of sense to both buyers and sellers, said Matthew Rhodes-Kropf, who teaches corporate finance at Columbia Business School.
Since companies have to pay interest before they pay dividends, bondholders get protection on the downside ahead of every stockholder. Once the stock goes up, then the value of their bonds goes up with the stock price.
"Investors get the security now — since the company practically has to go bankrupt before they don't get paid — and can participate in the upside when things turn around," he said.
In other words, if the stock remains listless, investors get the slow steady interest payments of corporate bonds. If the company recovers enough to push its stock above a set level, then investors can convert their bonds into stock that can be sold at a profit.
For companies, it gives them lower interest payments than regular debt when times are tight. "When good times return, companies want to restore their financial flexibility, turning debt into equity and cleaning up their balance sheet without having to issue new stock."
Citing applicable securities laws, Nortel would not provide details on the demand for its new seven-year convertible senior debt, which paid 4.25 percent and can be converted into shares when the stock reaches $10.
The Brampton, Ontario-based company originally was only seeking to raise $1 billion through its convertible bond offering, but subsequently decided to raise an extra $500 million for "general corporate purposes" after seeing the demand. The underwriters exercised options to purchase $300 million themselves.
Sprint and Lucent also expanded their initial $1 billion offers.
Investors are apparently trusting Nortel, which issued $1.5 billion of debt in February that yielded 6.13 percent, two weeks before disclosing a sharp downturn in its operations.
The company subsequently posted a $19.4 billion loss in the second quarter, writing off $12.4 billion in goodwill it had spent to buy other companies while its stock price was high.
"They underestimated the severity of the downturn, but a lot of others did too," says John Tysall, head of corporate ratings in Toronto for Standard & Poors, which downgraded Nortel's credit in July from A to BBB.
