LONDON, Sept 5 (IFR) - Whatever happened to bond investors
being the smartest guys in the room?
The logic behind the adage is simple: while every man and
his dog can take a punt on stocks, the world of fixed income is
largely open only to professional investors with expensive
So this week how exactly did an institutionally-held
corporate bond plummet 74 points in a single day?
Phones 4U's £205m payment-in-kind toggle note began Monday
bid at a cash price of 87. But after the UK phone retailer
announced that Vodafone would not be renewing its network
agreement the notes plunged to just 30 in less than two hours.
Management hurriedly arranged a conference call for midday
to reassure bondholders. Instead, after hanging up their phones,
investors hit the sell button even more vigorously and the notes
were soon as low as 13.
On the call management said they were "completely and
utterly surprised" by Vodafone's decision. Yet if Phones 4U was
so dependent on a single contract, why was the market marking
the PIK as high as 87 to begin with?
The first canary in the mineshaft stopped chirping in
January when the company was dumped by network operator O2. The
following month, rival Carphone Warehouse began exploring a
merger with Dixons, a firm slap in the face for Phones 4U given
its retail partnership with the electronic goods retailer.
Most stunningly though, news broke in May that private
equity owner BC Partners had written down the value of its stake
in the company by a whopping 86% to just EUR7.7m.
BC Partners, of course, used the PIK along with £25m of the
company's cash to fund a £223m dividend. The private equity firm
reportedly put in less than £200m of its own cash when it bought
the business in 2011.
"This was a classic suckers market; the only ones who
prepared themselves for this were BC Partners," said one
So how did investors get caught out so badly?
The answer lies in the collective delusion gripping the bond
market: relative value.
At one point in May, Phones 4U's senior secured notes were
bid at a 6.5% yield while the PIK was at 12.5%, an incredible
subordination premium given the leverage differential was not
This is the siren call of relative value.
Banks happily peddled this line. In early April, with the
PIK bid at 94.5 to yield 11.47%, Barclay's research team wrote:
"at current levels investors are adequately compensated for the
execution risk given Phones4u's solid cash flow generation."
There's been an "if you like that, you'll love this"
approach in credit for far too long now.
Like bank bonds? You'll love AT1!
Like corporate bonds? You'll love hybrids!
Like high-yield bonds? You'll love PIKs!
The fact is, a 600bp subordination premium counts for
nothing when a business gets wiped out. Credit investors need to
remember why they were hired: to do credit work.
(Reporting by Robert Smith, editing by Alex Chambers, Julian