Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

What's going on with Gogo?

If you have flown recently and used a device in the air, there's a good chance you have encountered Gogo, which provides in-flight internet service for major airlines. It planned to sell $525 million of junk bonds a few weeks ago in part to upgrade its technology, according to Bloomberg's Claire Boston.

The sale was going smoothly enough, with the notes even starting to trade. But then Gogo canceled the transaction abruptly, a rare event that late in the process. 

Gogo said the turnabout stemmed from a proposal it received from a "major" airline customer -- also known as American Airlines -- that could have materially changed the company's financial outlook. Since the negotiations were continuing, Gogo couldn't reliably tell investors what this meant for its future. 

That itself is perplexing. How often do possible contracts with major companies just pop up in the middle of a bond sale that would have such a big influence on their future?  

But then things got stranger. Gogo solidified the contract with American Airlines, although perhaps not exactly as it hoped. The company disclosed that the airline might pull its service from a large part of its fleet and crawled back to bond investors with hat in hand, looking for some cash in order to pay down existing debt and fund its operations. It offered an extra half a percentage point of yield to compensate for all the confusion, according to Bloomberg's Boston and Sridhar Natarajan.

Gogo's gyrations churn up a bunch of questions. First, there's the issue of the profitability of providing in-flight communications. Gogo is one of the main providers, but others such as ViaSat and Panasonic are muscling in on its turf. That's good for big airlines because it means more competition and theoretically better service and lower costs, but it could crimp Gogo. 

Flying Low
Shares of Gogo are down 46 percent this year
Source: Bloomberg

Second, there's a question about the solidity of Gogo's business. While it's understandable that last-minute problems can can stymie the best-laid plans, the sequence of events raises qualms about how much it relies on big contracts that can seemingly change unexpectedly and meaningfully. As Matthew Duch, a money manager at Calvert Investments said, "Is 50 basis points enough to compensate me for that? I don't think so."

And third, there's a broader question of what this deal says about the market. Gogo managed to sell these bonds Thursday, even though it is a highly leveraged company that's expected to be free cash-flow negative in the next few years. It is clearly in great need of the money, otherwise it wouldn't be offering a coupon of 12.5 percent when comparably rated companies are paying only 7.5 percent. 

Cash Burn
Gogo has been spending more money than it has as it expands
Source: Bloomberg
Figures for 2016 and 2017 are an average of analyst estimates collected by Bloomberg

And investors do appear to be somewhat cautious about a company that can decide to do a debt sale one day, change its mind, then change its mind again. Bond buyers have exercised somewhat more discipline in recent months, which is why there's been such a big divergence in yields on the riskiest junk bonds and safer ones.

Mind the Gap
Investors are demanding a bigger premium to own the riskiest junk bonds than they have in past years
Source: Bank of America Merrill Lynch index data

Still, Gogo's bonds found buyers, with the debt selling Thursday afternoon, and investors appear to be getting generally less risk-averse once again. They need to park their money somewhere, even a place they don't really want to put it, in order to earn some income on it. What's the alternative? U.S. Treasuries, with yields that are close to record lows? Japanese bonds that are charging investors to hold them?

So investors will pore over documents, ask management questions and then look at those fat yields and think that as long as a company survives for two, three or four years, they'll probably get their money back and then some. It's not a great option, but good ones are in short supply.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net