Thursday, October 21, 2010

Mispricing Risk on Bonds

Interest rates are at an all-time low.  Companies are able to borrow money and pay almost no interest under the most favorable of terms.  This one caught my eye:

SAN JOSE, Calif.--(BUSINESS WIRE)--eBay Inc. (NASDAQ:EBAY) today announced the pricing of a $1.5 billion underwritten public offering of its senior Notes, consisting of $400 million of 0.875% Notes due 2013 (the "2013 Notes"), $600 million of 1.625% Notes due 2015 (the "2015 Notes") and $500 million of 3.250% Notes due 2020 (the "2020 Notes"). The public offering price of the 2013 Notes was 99.793% of the principal amount, the public offering price of the 2015 Notes was 99.630% of the principal amount, and the public offering price of the 2020 Notes was 99.420% of the principal amount, in each case plus accrued interest, if any. The offering is expected to close on October 28, 2010.  eBay intends to use the net proceeds from the offering for general corporate purposes, which may include working capital, acquisitions and capital expenditures.
It is completely astounding that a company with a business model like eBay is able to borrow for:
- 2-3 years at under 1%
- 5 years at under 2%
- 20 years at a bit over 3%

These are not secured debt items; they are notes - and per the description above, eBay can use the money for anything they want, including working capital, which means that they can use the money for ANYTHING.  THIS IS LESS THAN 1% ABOVE THE RISK FREE RATE (i.e. what you can get for Treasuries).  This is absolutely unprecedented.

This article in today's Wall Street Journal essentially tells the same story with Wal-Mart.  Wal-Mart was also recently able to sell debt at an absurdly low premium over the risk free rate.  Per the article:

Wal-Mart sold $750 million worth of three-year bonds paying 0.75% a year. It sold $1.25 billion of five-year bonds paying 1.5%, $1.75 billion of 10-year bonds paying 3.25% and $1.25 billion of 30-year bonds paying 5%.
The difference between Wal-Mart and eBay is that WMT also has an instrument that delivers yield as well as some potential for appreciation; a stock paying a dividend.  The dividend on the shares of WMT yield a bit over 2% a year and receive preferential tax treatment (due to the dividends received deduction) to boot.  Per the article:
Wal-Mart has raised dividends by an average of 16% a year over the past decade. If it merely raises them by 10% a year in the future, the yield on the stock will surpass that on the 10-year bonds within about five years. It will surpass that on the 30-year bonds within 10 years.

I have no idea why someone would buy debt, which has many risks (the risk of inflation in the economy, as well as a company specific risk) with this sort of minuscule premium, especially when taxation is so unfavorable (it is taxed as ordinary income today and highly likely tomorrow).

This is the equivalent of a "bubble market" for bonds.

Cross posted at Chicago Boyz and Trust Funds for Kids

1 comment:

Dan from Madison said...

I am in the camp that firmly believes that the suckers are "all in" - the bond market.

I laugh every time I hear what the US Govt. is paying on their debt, it is ludicrous.

I just got paid my Altria dividend - even with the little uptick it is still a 6% yield. Think I will buy more today based on our highly detailed market research of last Friday night watching everyone smoke their brains out.

Comedy aside, the bond market is due for a major wipeout in the not too distant future.