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September 5, 2013 8:45 pm
Imagine: the biggest US corporate bond sale ever coming when interest rates are rising and investors are nervously watching events unfold in Syria. The reasons to stay away are obvious. But what of the buy case?
Next week Verizon will start pitching bonds to fund its $130bn purchase of Vodafone’s stake in Verizon Wireless. The bit sold in the US could hit the $20bn mark, which would set a record. Sales outside the US will probably follow.
Rising rates push prices of existing bonds down. Just ask anyone who bought into the offering that now holds the size record. Apple’s $17bn sale took place just before the Federal Reserve signalled reduced asset purchases, spiking Treasury yields. The price of Apple’s 10-year bonds has fallen more than a tenth since they were issued. Happily, rate increases do mean higher yields on new bonds. Late last year, Verizon sold 10-year bonds with a 2.45 per cent coupon. They now yield about 4.5 per cent, a spread of roughly 150 basis points over Treasuries. Based on existing market levels plus some premium for the size of the deal, investors could get a coupon at or around 5 per cent on new Verizon 10-year debt, about double last year’s bonds. (Unhappily, another surge in benchmark rates could cause losses for investors needing to sell before maturity).
The knock on Verizon’s stock – which offers a 4.4 per cent dividend yield – is rising competition. Verizon may have the best wireless asset in the world, but US mobile competition is set to turn nasty. Sprint, now the third-largest competitor after AT & T and Verizon (measured by customers under contract) is soon to be majority owned by the feisty SoftBank. And T-Mobile USA has been adding customers by slashing prices.
Competition could hit margins, and buying the rest of the wireless business will drive Verizon’s ratio of net debt to earnings before interest, taxes, depreciation and amortisation from 1.2 to 3. But even if the $30bn or so of ebitda that Verizon Wireless now generates is diminished, the new bondholders should get their coupons and, in time, their principal.
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