Two months after lending $10 billion to Qualcomm Inc., bondholders are getting a lesson in the risks of buying the debt of companies with activist shareholders.
The creditors found out last week that the chipmaker -- after posting its worst sales decline since 2009 -- is again considering splitting in two as part of a strategic review spurred by hedge fund Jana Partners LLC. Just two months earlier as it was marketing the bonds, the company told potential lenders that keeping the businesses together was the better strategy. Now the market value of the debt has dropped 4.3 percent and the bondholders are upset.
“Everybody knows this is a risk over three, four, five years -- no reasonable person should’ve expected it was a risk in two months,” said Scott Kimball, a fixed-income manager at Bank of Montreal’s Taplin Canida & Habacht unit, which owns the bonds. “We were surprised by it. That’s where they need to do damage control.”
The San Diego-based company said there has been no “material change” in its view, no decision has been made on a breakup and it’s only conducting a review.
“At the time, all things being equal, we felt it was more important to keep the companies together,” George Davis, Qualcomm’s chief financial officer, said of the offering during an interview at Bloomberg’s New York headquarters July 24. “But it’s something that we look at on a regular basis. Clearly you had an activist calling for it.”
Either way, the episode is serving as a wake-up call in a market where investors have snapped up an unprecedented $3.3 trillion of corporate bonds during the past two years in a bid to boost yields that have all but evaporated across fixed-income markets.
Activist shareholders are often looked at as potential risks to creditors because they push for changes that can siphon off cash or load up a company with more debt. Increasingly, they’re also pressuring for structural changes like mergers and spinoffs at the firms they target instead of just pushing for share buybacks and dividends, according to an April 7 report by Moody’s Investors Service.
“Shareholder activism is rarely good news for bond investors,” the Moody’s analysts, led by Chris Plath, wrote. Nowhere are those risks higher than in tech, which they said attracted 30 percent of all activist interest last year, the most of any sector.
Bonds of EBay Inc. fell immediately after it announced plans to split off its PayPal division last September, bowing to pressure from activist investor Carl Icahn. The news prompted ratings firms to review its credit for potential reductions, which were enacted this month when the unit was divested.
In Qualcomm’s case, Jana -- which owned 1.8 percent of the company’s outstanding shares as of March 31 -- asked the company in April to reconsider splitting its two main businesses, increase stock buybacks, cut costs and reduce the size of its 15-member board, among other shareholder-friendly changes. The fund said the chip unit hampers the overall valuation of the company, the shares of which have lagged behind peers, according to a July 21 report by financial-research firm CreditSights Inc.
Qualcomm Chief Executive Officer Steve Mollenkopf said on an April earnings call that, while the board and management “constantly and periodically” discuss the company’s structure, investors should “think of the businesses as having significant synergies.”
Then, on July 22, the company announced a realignment plan that incorporated many of Jana’s suggestions, promising a structural review “including possible business separation alternatives.”
Charles Penner, a partner at Jana, declined to comment on bondholder sentiment in response to the announcement.
“We have made no decision to do anything other than review again,” Qualcomm spokeswoman Clare Conley said. “Similarly, Jana has been clear that they are not calling for a separation of the businesses. They are simply asking for a review.”
Investors are concerned that if the company does move to split in two it would make both units less valuable to bondholders, since Qualcomm’s higher-margin licensing business provides the cash used by the chip unit for research and development. It could also choke the licensing unit’s pipeline of technology, CreditSights analyst Erin Lyons wrote before the announcement.
“People wouldn’t have bought the deal if they thought that there was a decent chance of a split happening,” Lyons said by phone this week. “I think they got a lot of comfort from management that it wouldn’t happen. That’s what’s not sitting well with investors.”
Bondholders are also spooked because one of the two board members Qualcomm added at Jana’s behest has experience breaking up businesses.
Tony Vinciquerra, whom Qualcomm appointed to its board with Mark McLaughlin, formerly served as director of Motorola Inc., where “he was involved in evaluating and implementing its separation,” Mollenkopf told investors in the July earnings call. The company split in two in January 2011. Vinciquerra took a seat at the spun-off unit.
“They broke up that company,” Taplin Canida’s Kimball said. “Their bonds had a significant recovery and rallied, but it was a very depressing ride for bondholders.”
Like most investment-grade bonds, the notes Qualcomm issued don’t protect investors in the event that the review calls for a split. That opens the door for buyers to be left holding bonds of a business that’s less profitable -- and less equipped to repay its debt.
That didn’t stop investors from piling into the debt, producing enough demand that the company was able to sell it at lower yields than initially offered.
Not Joe Mayo, however. The head of credit research at Conning & Co., which oversees about $92 billion, said Jana’s activist involvement in the firm and its public intention to split Qualcomm made the bonds too risky to hold without those protections.
Since the sale, the debt has tumbled, with $2 billion of 10-year, 3.45 percent notes dropping to 94.2 cents on the dollar.
“We passed completely on the new issue,” Mayo said. “It’s nice when management says something. But if they really mean it, we’d like to see it in writing.”