Don't roll the dice on these high-yield plays

Moody's has concluded that the bonds of some high-profile leveraged buyouts are too junky for most investors.

By The Fiscal Times Dec 9, 2011 10:06AM
bondBy Suzanne McGee, The Fiscal Times

To some fund managers, they are known as the "Big Five:" The junk bonds that Clear Channel Communications, Harrah's Entertainment, Energy Future Holdings (the utility formerly known as TXU), Realogy, and Hawker Beechcraft originally issued in the midst of the leveraged buyout frenzy between 2006 and 2008.

All are trading at eye-popping yields that rise into the mid-teens. But to many investment managers, they are distinctive not because of the high yields, but because even as the default risk has ebbed for junk bonds as a whole, and the overall rate of defaults has fallen, the securities of the Big Five are still seen as perilous.

Now Moody's Investors Service has joined the party, issuing a report Wednesday that's the equivalent of an alert from the Better Business Bureau. The credit-rating agency studied the 40 leveraged buyouts that it has tracked since the height of the bubble – a period when bankers who asked whether such bonds were really a good deal for investors were told to shut up and just sell them – and concluded that bonds from the Big Five carry disproportionate risks for investors.

And the private-equity investors behind these deals aren’t likely to fare much better: The ratings agency added it's going to be hard for them to earn a decent return. Collectively, the companies "demonstrated lackluster performance and have had a high default rate," says Lenny Ajzenman, a Moody's senior vice president.

Some of the companies have already claimed high-profile victims. Warren Buffett invested $2 billion in TXU bonds with great fanfare four years ago, shortly after the company's LBO (backed by legendary firm KKR as well as Texas Pacific Group). Buffett remains a major investor, although Berkshire Hathaway earlier this year reported write-downs on the value of its bond portfolio, with much of the loss believed to stem from the TXU investment.

While some of the 40 companies studied by Moody's have seen an improvement in the quality of their balance sheets and their debt – HCA is a case in point – one-fifth are still at high risk, including the Big Five. For example, Hawker Beechcraft, the company formed to buy out defense giant Raytheon's aircraft business, has a lot of debt on its balance sheet, and may have to either restructure that debt or risk default in the next few years.

So far, only seven of the 40 companies Moody's surveyed have had an IPO – hardly a surprise when the rating agency describes the group as posting softer earnings, higher default rates, more sluggish revenue growth and less stable finances. Only five have paid "material dividends" to their investors, Moody's says. And looming on the horizon is the need to refinance massive amounts of debt between 2013 and 2015.

That means that LBO firms will be badgering investment bankers to push forward with IPOs of these companies in 2012 and 2013, pushing some of the risk into the hands of stock market investors. Those investors may want to be wary before snapping up stock in any of the Big Five or their counterparts, regardless of the hype, and do some extra due diligence on any offerings backed by buyout funds.

Related links:
9 Common Mistakes Investors Make
Why Rogue Traders Still Prosper on Wall Street
Why the Luxury Market May Lose its Luster

0Comments

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

115
115 rated 1
269
269 rated 2
445
445 rated 3
614
614 rated 4
684
684 rated 5
678
678 rated 6
608
608 rated 7
454
454 rated 8
310
310 rated 9
138
138 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
AAPLAPPLE Inc10
ARCPAMERICAN REALTY CAPITAL PROPERTIES Inc10
ATVIACTIVISION BLIZZARD Inc10
BIDUBAIDU Inc10
BMYBRISTOL-MYERS SQUIBB CO.10
More

VIDEO ON MSN MONEY

ABOUT

Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.