Verizon Pays $5.1 Billion in Extra Interest: Corporate Finance
The rally in Verizon Communications Inc. (VZ)’s bonds after its record $49 billion offering shows the phone company will pay as much as $5.1 billion more in interest for the certainty of completing the deal a week before the Federal Reserve may curtail its record stimulus.
Yields on the securities have plummeted since the Sept. 11 offering, with the $15 billion of 6.55 percent bonds due in September 2043, the largest piece of the eight-part deal, trading at 109.5 cents on the dollar yesterday, 9.6 cents more than the issue price. That reduced the yield to 5.88 percent, suggesting the company will pay about $101 million of extra interest a year on those notes than if it sold them at current market rates.
“I don’t think they had much of a choice than to offer a deal that was cheap,” Anthony Valeri, a market strategist in San Diego with LPL Financial Corp., which oversees $350 billion, said in a telephone interview. “It’s hard to fault them with all the uncertainty ahead of the Fed meeting and a weak bond market.”
Verizon, which is buying Vodafone Group Plc (VOD) out of their U.S. wireless partnership in the biggest purchase in more than a decade, offered bond buyers above-market rates to lock in financing before a Fed decision today on whether to start scaling back stimulus measures that have suppressed borrowing costs. With interest rates rising and investment-grade corporate bonds facing their first annual loss since 2008, the company tapped the market at a time when yields remain almost a percentage point below the average of the past five years.
Bob Varettoni, a Verizon spokesman, declined to comment on the interest costs.
Societe Generale SA analysts said before the sale that the company might initially issue $20 billion to $30 billion, mostly dominated in dollars, while also including euros, British pounds and possibly Japanese yen, according to a report dated Sept. 8. Verizon decided not to market euro-denominated bonds as had been planned for Sept. 12 and 13, according to a person familiar with the transaction, who asked not to be identified citing lack of authorization to speak publicly.
The company intended to use $40 billion to $50 billion of bonds to help fund the $130 billion purchase of Vodafone’s stake in Verizon Wireless, a person briefed on its plans who asked not to be identified, citing lack of authorization to speak publicly on the matter, said before the U.S. sale.
Verizon faces a $10 billion fee should the deal be terminated because it can’t line up financing, the New York-based company said in a filing. The penalty was greater than a breakup fee of $4.65 billion should its board change its recommendation on the share issuance and of $1.55 billion should it fail to garner enough shareholder support.
The company issued $45 billion of fixed-rate bonds with maturities ranging from three to 30 years that will pay about $45.3 billion in interest over their lives, according to data compiled by Bloomberg. It also sold $4 billion of floating-rate notes in two parts.
The decline in yields on the fixed-rate securities implies the company will pay $327 million in extra interest over the next 12 months, Bloomberg data show. The amount of extra interest Verizon will pay over the bonds’ lifetimes is more than the average $4.7 billion it earned each year over the past decade.
“Verizon stakeholders would like the company to capitalize on lowering its cost of capital as efficiently and effectively as possible,” Todd Lowenstein, a stock portfolio manager with Highmark Capital in Los Angeles, who doesn’t own Verizon or Vodafone shares, said by e-mail. “Given this was an elephant-size deal there were multiple considerations involved,” he said. “I wouldn’t penalize them too much for not getting the absolute cheapest rate.”
The 10 largest buyers obtained $22.1 billion, or 45 percent of the offering, with the top five buying $16.25 billion, according to a person familiar with the sale, who asked not to be identified citing lack of authorization to speak publicly.
Pacific Investment Management Co., which runs the world’s biggest bond fund, purchased $8 billion of the debt while BlackRock Inc. (BLK), the No. 1 shareholder of Verizon, was awarded about $5 billion, according to people familiar with the sale.
Michael Reid, a Pimco spokesman, and Farrell Denby, a BlackRock spokesman, declined to comment.
Verizon’s $11 billion of 5.15 percent, 10-year securities climbed to 105 cents from 99.7 cents at issuance, with the yield dropping to 4.51 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That implies the company could have saved $70.8 million per year in interest on that debt.
“Verizon was prudent to move quickly on the bond offering,” said Kevin Roe, an analyst with Roe Equity Research based in Dorset, Vermont. “The very fact that rates are so uncertain and volatile is reason enough to secure the proceeds for the Vodafone deal sooner rather than later.”
While yields on dollar-denominated bonds sold by investment-grade companies have climbed to 3.53 percent from a record low 2.65 percent in May, they are still below the 4.4 percent average of the past five years, according to Bank of America Merrill Lynch index data. The debt is down 3.85 percent this year after gaining 10.4 percent in 2012, the first decline since a 6.82 percent loss in 2008, the data show.
The Fed’s stimulus measures, which have included holding its target interest rate at almost zero for more than four years and $85 billion of monthly bond purchases, have helped push down yields from an average of 5.17 percent from 2004 to 2006, before the financial crisis and an average of 8.24 percent in December 2008, when the central bank announced its first bond-buying program.
The benchmark 10-year Treasury yield has risen 0.8 percentage point to 2.85 percent since May 22, when Chairman Ben. S. Bernanke said the central bank could start curtailing its $85 billion in monthly bond purchases sometime this year if there was “real and sustainable progress in the labor market outlook.”
The Fed will scale back its bond purchases to $80 billion following the two-day meeting that ends today, according to the median estimate of economists surveyed by Bloomberg. The central bank will keep purchases of mortgage-backed securities at the current monthly pace of $40 billion, while cutting Treasury bond purchases to $40 billion from $45 billion.
“They were really eager to get a deal done because there are uncertainties and it was a huge amount of debt,” Ping Zhao, an analyst at bond researcher CreditSights Inc. in New York, said in a telephone interview. “We’ve never seen $49 billion from one company in one day.”