Verizon Communications Issues Bonds, Why Investors Should Pass

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Verizon Communications Issues Bonds, Why Investors Should Pass
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We are going to see the biggest corporate bond deal price today.  Verizon Communications Inc. (NYSE:VZ) is raising money to buy out Vodafone Group Plc (NASDAQ:VOD) (LON:VOD)’s 45% stake in Verizon Wireless.  The amount sold will be at least $20 billion, and could be as  high as $50 billion.  They are going to have to pay up to do so, because:

Verizon Communications Issues Bonds, Why Investors Should Pass

  • Verizon Communications already has almost $50 billion in debt
  • Large deals run into the position limits of institutional bond investors.

Institutional bond investors  typically have holdings limits based on:

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  • Percentage of exposure to a sector
  • Percentage of exposure to an industry
  • Percentage of exposure to a ratings category

There will be other limits tailored to the needs of the client, which frequently stem from the length of their explicit or implicit liabilities.  Explicit liabilities are simple — you know when cash will be demanded.  Implicit liabilities estimate when cash will come or leave depending upon performance.

With respect to bond ratings, Verizon is in a tough spot, because it will be the largest nonfinancial bond issuer, with nearly $100B in debt, versus AT&T, with $76B in debt.  That presents its own challenge, because the US telecom sector is dominated by two companies, Verizon Communications and AT&T.  How much do you want to buy when two companies dominate the sector?  One failure would be huge to the bond market, but then again, duopolies tend to be profitable, so long as they don’t overleverage, like Fannie and Freddie.

Big bond deals are tough, because many bond managers will say, “I am already full on the name,” or “I can only take $XX million more of the name, and then I am full.”  This is especially true for Verizon, since they are rated Baa1/BBB+/A- from Moody’s, S&P, and Fitch.  That’s a high BBB rating, but far better to have a low single-A rating.

Thus the pricing has to be attractive, so that buyers that are not dedicated to corporates have interest — balanced funds, incomefunds, endowments and pension funds.

My Advice

Unless the yields are similar to those for BB junk bonds, I would pass on this deal.  The reasons are simple:

  • Typically the results on large corporate deals are bad in the short-run.
  • You will not have a large audience to re-sell your bonds to.  Most parties will be stuffed full.
  • Technology is sufficiently dynamic that Verizon Wireless could lose its protected boundaries much as landlines have.

I am usually a skeptic of big bond deals.  It is usually a sign of weak thinking among buyers.  I avoided big deals during 2001-3, and ended up the better for it.

So be wary, and avoid Verizon bonds for a time, until the market normalizes.  It looks like the syndicate will stuff the market full, but good.

Full disclosure: long VOD, and as a result will probably receive shares of Verizon Communications

By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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