Revenge of the Junk Bonds

Telling a man who's been hit by a truck and lying in intensive care that he "looks great and is really lucky" may be met with a groan of self-pity. But let him know that not long ago he was declared dead and doctors almost pulled the plug, and watch him grin.

This is the condition that the telecom high-yield debt market now finds itself: happy to be alive.

Last November, one errant industry prognosis had the debt market for telcos officially closed for the next 12 to 18 months. Wrong. Since January 3, when the Federal Reserve Open Market Committee made a surprise interest-rate cut, the junk-bond market reopened and business boomed.

Quick on the draw was Charter Communications, raising $1.75 billion. Then Comcast issued $2 billion in debt, and McLeodUSA sold $750 million in high-yield notes. With lower interest rates, these once-risky loans began attaining "value" status.

Through March 25, more than $17 billion in telecom high-yield domestic debt has been issued. According to Morningstar, the Chicago-based market researcher, through mid-March the average return on a wireline high-yield bond fund was 2.2%, and wireless funds eked out a 0.8% profit. Both were a nice turnaround from the 17% and 19% losses, respectively, incurred in 2000 — and a lot better than equities' performance so far this year.

But let's be clear: the junk-bond market is far from solid. Gary Jacobi, an analyst with Deutsche Banc Alex. Brown, agrees that the fixed-income market has reopened and that telcos can borrow again, but with caution. Jacobi believes that the telecom fixed-income market is "probably more closely tied to the performance of the Nasdaq than prevailing interest rates."

Digging Out Of Debt

David Ellis, a high-yield fund manager at J.P. Morgan, also believes the recent dip is a temporary setback.

"Banks got overextended, and a lot of capital got tied up in Europe due to debt accumulated through buying wireless assets," he says. Now companies such as Vodafone, British Telecom and France Telecom are scrambling to reduce debt levels, strengthen balance sheets and avoid further credit rating downgrades.

Deserving players are going to be much healthier by year's end, according to Walter McGuire, a strategist with Deutsche Banc. McGuire believes that once Europe absorbs some of the high-yield bond supply and stabilizes its credit risk, performance will improve and more capital will become available. He also notes the strong demand for France Telecom's whopping $13.6 billion in 10-year notes, issued March 7, and SBC Communications' sale of $1.25 billion in 10-year notes on March 12 as indicative "of an opening window." He expects such high-yield funds to deliver 12% to 14% returns this year.

Healthier, wealthier and, perhaps, wiser. Now that's a recipe for happiness.

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in The Net Economy.