Bondholder Beware: Value Subject To Change Without Notice

No more Marriotts. That's the battle cry of disgruntled bondholders after the lodging company skewered them last fall with a proposal to split itself into a highly profitable hotel operator and a so-so hotel-property owner. Bondholders flew into a rage over the plan to saddle the property owner with most of parent Marriott Corp.'s $2.9 billion debt, leaving creditors with a flimsy asset base to support their bonds. Since then, Marriott's stock price has surged 35%, while its bonds have dropped 30%.

Although a proposed settlement, announced Mar. 11, might defuse the situation by shifting some debt back to the operating outfit, debtholders ranging from Dreyfus Corp. to the California Public Employees' Retirement System are calling for tighter covenants in bond contracts to thwart recurrences. Says F. John Stark III, counsel to PPM America Inc., an investment adviser to dissident creditors: "There will be a big move for greater protection."

Not likely. Bondholders can--and will--fuss all they like. But the reality is, their options are limited: Higher returns or better protection. Most investors will continue to go for the gold.

WIPEOUT. You can look it up. Four years ago, in the wake of the RJR Nabisco Inc. takeover, bondholders were shocked when the company's vast new debt drove its bonds into junk status, wiping out millions of dollars' worth of value. The bond buyers' response in 1989 was to insist on "event-risk" language for investment-grade debt issues: Covenants requiring companies to redeem bonds at face value if they get hit with a lower credit rating.

These hard-line covenants, also known as "poison puts," faded fast, though: The number of issues so protected, 40 in 1989, dropped to 6 last year. Becton Dickinson & Co., for instance, issued $100 million in bonds with poison puts in early 1989, but two years later, it floated the same amount of debt with no such protection--and had no trouble selling it.

What has changed? The takeover era is over, and few corporations are leveraging themselves into junk the way RJR Nabisco did. Equally important, today's falling interest rates make loose-covenant bonds more attractive. Their greater risk means they pay higher yields--up to 0.6 points more than downgrade-protected debt instruments.

Will there be future Marriotts? Sure. It's likely that the hotelier will get away with its lopsided split, emboldening copycats. The sequels just won't be as brazen. But even though dissidents such as PPM are vowing to ignore Marriott's compromise and press on with a lawsuit, courts tend to favor shareholders--who are delighted by the deal--over creditors. And bond investors, compensated with richer yields, will have short memories. Caveat emptor.

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