SINGAPORE (Oct 22): Michael Milken, the junk bond king of the 1980s, is still remembered as much for his role in developing the market for high-yield bonds as the securities violations that led to his paying massive fines, serving jail time and being permanently banned from the securities business.
Update: Temasek exercises upsize option for retail bonds to $300 mil; trading starts this Friday
Junk bonds were traditionally investment-grade bonds gone wrong. As investors fled in the face of an increased likelihood of default or credit rating downgrade, the market value of these bonds tanked, resulting in their yields shooting up. Milken realised that a portfolio of junk bonds could produce better returns than a portfolio of investment-grade bonds, even after taking account of the increased risk of default. He made a fortune for himself at the Wall Street firm Drexel Burnham Lambert advising investors and upstart companies to take advantage of these debt instruments.
Milken argued that it was young companies, many funded by high-yield bonds, that drove growth in the US through the 1970s and 1980s. He also pointed out that the US itself was not an investment-grade prospect when it became independent more than two centuries ago. “Junk bonds? Perhaps there’s a better name for the bonds that fuel 95% of American business,” he is once quoted to have said. “Perhaps something like corporate growth bonds. Or state development bonds. Or job creation bonds.”
Unfortunately, Milken sowed the seeds of his own downfall when he got involved in raising money for big leveraged buyouts. In particular, those deals linked him to Ivan Boesky, the infamous stock arbitrageur, who is said to have provided some of the inspiration for the creation of Gordon Gekko, the main protagonist in the movie Wall Street. In 1986, Boesky pleaded guilty to securities fraud and implicated Milken in a number of illicit transactions.
Milken’s exploits three decades ago came to mind while I was surveying the market for opportunities over the last couple of weeks. On the face of it, this seems like the moment to reduce risk. Stocks had a strong run in 2016 and 2017. But they have weakened this year in the face of concerns about a US-China trade war, shifting geopolitics and tightening US monetary policy. Small-time investors like me do not have a lot of options when it comes to bonds, though. While my bankers often show me corporate bonds they have for sale, I have VIEWS always declined because they required a minimum investment of $250,000. That large ticket price would make it hard for me to build a really diversified portfolio of bonds. I would simply be taking a concentrated bet on the creditworthiness of a handful of corporates.
There are, of course, lots of bond funds available in the market. But these funds are not quite the same thing as owning a bond directly. Investors do not lose money if they hold a bond to maturity, unless the issuer runs into financial trouble. On the other hand, there is no certainty of getting out of a bond fund without losing money, even if there are no defaults by the issuers of any of its holdings.
New bond issues
Now, things are changing. This past week, Temasek Holdings said it would issue $400 million of five-year guaranteed notes. Half of this was earmarked for sale to institutional investors, and is said to have been well-received. The order book for this initial allocation of $200 million came in at $1.438 billion, from a total of 76 accounts. The coupon rate was set at 2.7%. The other $200 million worth of notes is being offered to retail investors in denominations of $1,000 with the same coupon.
Temasek has been assigned an overall corporate credit rating of “Aaa” by Moody’s Investors Service, and “AAA” by S&P Global Ratings. The notes it is issuing are expected to be accorded the same ratings.
The notes could well trade at a slight premium in the market. Their coupon is a touch above the yield on five-year Singapore government bonds of 2.32% to 2.34%. The most recent five-year HDB bonds are trading around 2.64%. Investors who put money in the November issue of Singapore Savings Bonds would get an average return of 2.22% a year if they hold for five years.
In June, a unit of Temasek created a stir in the market with a retail bond issue backed by a portfolio of private-equity investments. A total of $242 million worth of the so-called Astrea IV Class A-1 bonds was issued, half of them through a public offering with a minimum subscription of $2,000. The yield on these bonds was set at 4.35% by institutional investors who bought the other half of Class A-1 bonds.
These bonds are callable in five years. If they are not redeemed at that time, the interest they offer will be stepped up by one percentage point. The final maturity is in 10 years. The bonds are part of a total of US$501 million ($691 million) in bonds raised on the back of cash flows from a US$1.1 billion portfolio of 36 private-equity funds, managed by 27 managers. These investments are spread across about 600 portfolio companies, of which 62% are in the US and the rest in Europe and Asia. The Astrea IV Class A-1 bonds have been trading well above par since they were issued.
We are nowhere close to having a really vibrant retail bond market, though. Besides the Astrea IV Class A-1 bonds, there are only a dozen other retail bonds listed on the Singapore Exchange, two of which appear to be suspended. Among the more recognisable issuers are property names such as Oxley Holdings, Frasers Property and CapitaLand Mall Trust.
‘Optimal capital structures evolve’
Where could the new issues of debt securities come from? Certainly, it would be great if the likes of Temasek pushed out more bonds for retail investors. But perhaps Singapore’s corporate sector should also review their businesses and determine whether their own capital structures need to be adjusted.
Milken was not just a remarkable salesman who widened the market for high-yield bonds. He also recognised the value that could be created when companies adopt the right capital structure at the right time. In April 2009, in the wake of the global financial crisis, he noted in a column in The Wall Street Journal that many US companies made a mistake of buying back stock during the boom instead of conserving cash for the credit crunch that eventually came.
“The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors — the company and its management, industry dynamics, the state of capital markets, the economy, government regulation and social trends. When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies,” he said in the column.
On the other hand, there are times when it makes sense for corporates to pile on debt, he said in the same column. “The decision to increase or decrease leverage depends on market conditions and investors’ receptivity to debt. The period from the late 1970s to the mid-1980s generally favoured debt financing. Then, in the late 1980s, equity market values rose above the replacement costs of such balance-sheet assets as plants and equipment for the first time in 15 years. It was a signal to deleverage.”
Milken concluded by saying: “History isn’t a sine wave of endlessly repeated patterns. It’s more like a helix that brings similar events around in a different orbit.” In the wake of the global financial crisis, it was clear that corporates needed to deleverage. But where are we now in the swirling helix of economic and market cycles? Some would argue companies should reduce their debt loads and hold on to their cash as interest rates rise. Others would say that interest rates are going up because growth has been strong and inflation is beginning to rise as unemployment falls and capacity utilisation tightens.
My own view is that corporates should be thinking and talking about expansion instead of battening down the hatches. Prioritising share buybacks and dividend payouts would be the wrong move. To be sure, some corporates are in businesses beset by deteriorating industry dynamics. And, technological disruption is creating uncertainty about the future. Yet, that is exactly why these companies should be boldly trying to chart a new direction. And, they could be rewarded with a stronger investor following if they succeed.
More corporate deals?
Case in point: StarHub has lost more than half its market value since April 2015, as its pay-TV business shed subscribers and concerns mounted about the entry of a fourth mobile phone player in the market. Its results have also been weak. For 1HFY2018, it reported nearly 20% y-o-y decline in earnings. For FY2017, it reported earnings that were more than 27% lower than its earnings the previous year, which were more than 8% below the year before that. It declared dividends of 16 cents a share for FY2017, down from the 20 cents a share it had declared for the preceding three years. Even with its deteriorating business, it has committed to paying four cents a share every quarter for FY2018. StarHub also recently announced plans to reduce costs, by laying off staff and sharing infrastructure with other players.
Yet, the dividend yield of nearly 8.2% its shares are offering does not have investors stampeding to its door. In fact, StarHub’s perpetual securities are holding up better. Last year, the company issued $200 million perpetual securities with a coupon rate of 3.95%. The securities are trading less than 2% below par. Are cost-cutting measures and commitments to a certain dividend payout what stock investors really want from StarHub? Or would the market react better to a reduced dividend and major capital- raising plan to fund a bold expansion that reshapes its whole business model — in the way that the 2001 purchase of Singapore Cable Vision did?
M1, the mobile phone player StarHub overtook more than a decade ago, could be about to embark in a brave new direction. On Sept 27, Keppel Corp and Singapore Press Holdings (SPH) announced a general offer for M1 at $2.06 a share. Keppel also announced plans to take its 79.22%-owned subsidiary Keppel Telecommunications & Transportation private at $1.91 a share. Keppel owns its stake in M1 through Keppel T&T.
Instead of allowing Keppel and SPH to gain outright control of M1, should StarHub team up with Axiata and make a counter-offer? Could that pave the way for a broader corporate restructuring involving Axiata’s regional assets? In the meantime, could Sembcorp Marine make an offer for Keppel’s offshore and marine business? And, farther afield in the local market, could Singapore’s property developers or manufacturers make a bid for industrial property assets around the region in anticipation of production capacity moving out of China as its labour costs rise?
Clearly, I’m just speculating about all of this. But I would not be surprised if these sorts of discussions are already happening in Singapore’s boardrooms. With ambitious growth plans and new issues of stocks and bonds, the local corporate sector could do a lot to enliven the local stock and bond markets. And, with any luck, they will manage to avoid the securities violations that landed Milken in trouble.
This story appears in The Edge Singapore (Issue 853, week of Oct 22) which is on sale now. Subscribe here
