Custom Search

A Debt by Any Other Name

The word debt sounds straightforward, but companies enter into a number of financial arrangements that look suspiciously like debt yet are treated differently in the accounts. Some of these obligations are easily identifiable. For example, accounts payable are simply obligations to pay for goods that have already been delivered and are therefore like a short-term debt.

Other arrangements are not so easy to spot. For example, instead of borrowing money to buy equipment, many companies lease or rent it on a long-term basis. In this case the firm promises to make a series of payments to the lessor (the owner of the equipment). This is just like the obligation to make payments on an outstanding loan. What if the firm can`t make the payments? The lessor can then take back the equipment, which is precisely what would happen if the firm had borrowed money from the lessor, using the equipment as collateral for the loan.

The Terms of Heinz`s Bond Issue

Now that you are familiar with some of the jargon, you might like to look at an example of a bond issue. Table 5.9 is a summary of the terms of a bond issue by Heinz taken from Moody`s Industrial Manual. We have added some explanatory notes.

INNOVATION IN THE DEBT MARKET

We have discussed domestic bonds and eurobonds, fixed-rate and floating-rate loans, secured and unsecured loans, senior and junior loans, and much more. You might think that this gives you all the choice you need. Yet almost every day companies and their advisers dream up a new type of debt. Here are some examples of unusual bonds.

Indexed Bonds. We saw in earlier how the United States government has issued bonds whose payments rise in line with inflation. Occasionally borrowers have linked the payments on their bonds to the price of a particular commodity. For example, Mexico, which is a large oil producer, has issued billions of dollars worth of bonds that provide an extra payoff if oil prices rise. Mexico reasons that oil-linked bonds reduce its risk. If the price of oil is high, it can afford the higher payments on the bond. If oil prices are low, its interest payments will also be lower. The Swiss insurance company Winterthur has also issued an unusual bond with varying interest payments. The payments on the bonds are reduced if there is a hailstorm in Switzerland which damages at least 6,000 cars that have been insured by Winterthur.5 The bondholders receive a higher interest rate but take on some of the company`s risk.

LEASE Long-term rental agreement.

1. A debenture is an unsecured bond.

2. Coupon is 6.375 percent. Thus each bond makes an annual interest payment of .06375 АГАз $1,000 = $63.75.

3. Moody`s bond rating is A, the third-highest quality rating.

4. Heinz is authorized to issue (and has outstanding) $250 million of the bonds.

5. The bond was issued in July 1998 and is to be repaid in July 2028.

6. Interest is payable at 6-month intervals on January and July 15.

7. A trustee is appointed to look after the bondholders` interest.

8. The bonds are registered. The registrar keeps a record of who owns the bonds.

9. The bond can be held in multiples of $1,000.

10. Unlike some bond issues, the Heinz issue does not give the company an option to call (i.e., repurchase) the bonds before maturity at specified prices. Also Heinz does not set aside money each year in a sinking fund that is then used to redeem the bonds.

11. The bonds are not secured, that is, no assets have been set aside to protect the bondholders in the event of default.

12. However, if Heinz sets aside assets to protect any other bondholders, the debenture will also be secured on these assets. This is termed a negative pledge clause.

13. The bonds were sold at a price of 99.549 percent of face value. After deducting the payment to the underwriters the company received $986.74 per bond. The bonds could be bought from the listed underwriters.

H. J. Heinz Company 6.375% debentures, due 2028 RatingБІАААдA

AUTH. $250,000,000: outstg. $250,000,000.

DATED July 10, 1998. DUE July 15, 2028.

INTEREST J&J 15.

TRUSTEE First National Bank of Chicago.

DENOMINATION Fully registered. $1,000 and integral multiples thereof. Transferable and exchangable without service charge.

EARLY REDEMPTION The debentures are not redeemable prior to maturity.

SECURITY Not secured. Ranks equally with all other unsecured and unsubordinated indebtedness of the Company. Company or any affiliate will not create as security for any indebtedness for borrowed money, any mortgage, pledge, security interest, or lien on any stock or any indebtedness of any affiliate . . . without effectively providing that the debentures shall be secured equally and ratably with such indebtedness, unless such secured debt would not exceed 10% of Consolidated Net Assets.

OFFERED $250,000,000 at 99.549 plus accrued interest (proceeds to Company 98.674) thru Goldman, Sachs & Co., J. P. Morgan & Co., Warburg Dillon Read LLC.

Marriott Plan Enrages Holders of Its Bonds

Marriott Corp. has infuriated bond investors with a restructuring plan that may be a new way for companies to pull the rug out from under bondholders.

Prices of Marriott`s existing bonds have plunged as much as 30% in the past two days in the wake of the hotel and food- services company`s announcement that it plans to separate into two companies, one burdened with virtually all of Marriott`s debt.

On Monday, Marriott said that it will divide its operations into two separate businesses. One, Marriott International Inc., is a healthy company that will manage Marriott`s vast hotel chain; it will get most of the old company`s revenue, a larger share of the cash flow and will be nearly debt-free.

The second business, called Host Marriott Corp., is a debt-laden company that will own Marriott hotels along with other real estate and retain essentially all of the old Marriott`s $3 billion of debt.

The announcement stunned and infuriated bondholders, who watched nervously as the value of their Marriott bonds tumbled and as Moody`s Investors Service Inc. downgraded the bond to the junk-bond category from investment-grade.

Price Plunge

In trading, Marriott`s 10% bonds that mature in 2012, which Marriott sold to investors just six months ago, were quoted yesterday at about 80 cents on the dollar, down from 110 Friday. The price decline translates into a stunning loss of $300 for a bond with a $1,000 face amount.

Marriott officials concede that the company`s spin off plan penalizes bondholders. However, the company notes that, like all public corporations, its fiduciary duty is to stockholders, not bondholders. Indeed, Marriott`s stock jumped 12% Monday. (It fell a bit yesterday.)

Bond investors and analysts worry that if the Marriott spin off goes through, other companies will soon follow suit by separating debt-laden units from the rest of the company. БІАААм Any company that fears it has underperforming divisions that are dragging down its stock price is a possible candidateБІАААн for such a restructuring, says Dorothy K. Lee, an assistant vice president at Moody`s. If the trend heats up, investors said, the Marriott restructuring could be the worst news for corporate bondholders since RJR Nabisco Inc.`s managers shocked investors in 1987 by announcing they were taking the company private in a record $25 billion leveraged buy-out. The move, which loaded RJR with debt and tanked the value of RJR bonds, triggered a deep slump in prices of many investment-grade corporatebonds as investors backed away from the market.

Strong Covenants May Re-Emerge

Some analysts say the move by Marriott may trigger the re-emergence of strong covenants, or written protections, in future corporate bond issues to protect bondholders against such restructurings as the one being engineered by Marriott. In the wake of the RJR buy-out, many investors demanded stronger covenants in new corporate bond issues.

Some investors blame themselves for not demanding stronger covenants. БІАААм It`s our own fault,БІАААн said Robert Hickey, a bond fund manager at Van Kampen Merritt. In their rush to buy bonds in an effort to lock in yields, many investors have allowed companies to sell bonds with covenants that have been БІАААм slim to none,БІАААн Mr. Hickey said.