Where The Junk Biz Is Really Jumping
Last August, Brazil's NetSat Servicos Ltda., a unit of a telecommunications consortium owned by News Corp., Tele-Communications Inc. and Globo, a Brazilian media conglomerate, needed $200 million to bankroll an ambitious satellite-TV startup. Like many entrepreneurial U.S. companies, it turned to the junk-bond market. Yes, the junk-bond market.
Two decades after Michael R. Milken created a brand new source of financing for capital-starved, lower-tier American companies, investment bankers of all stripes are combing Latin America, Asia, and Eastern Europe as well as industrialized nations for opportunities to arrange high-yield debt offerings.
Fueled by continued economic growth in emerging markets, low interest rates, and enormous global liquidity, the international junk market, which three years ago barely existed for non-U.S. issuers, is expanding dramatically. In 1996, high-yield debt issuance by foreign companies surged to $10.37 billion, or 58 issues, from the 34 offerings valued at $7.14 billion brought to market in 1995, according to Merrill Lynch & Co.
In contrast to the U.S. high-yield market, which endured years of snickering before it gained mainstream acceptance, the overseas junk-bond business seems to have achieved instant respectability. "High-yield capital is helping to build the infrastructure and increase growth" in developing countries, says Christopher A. Johnson, Merrill's head of high-yield finance. Merrill and Morgan Stanley & Co. dominate the business with a 20% share each.
Many overseas borrowers, especially emerging- market companies and overseas units of U.S.-based companies, actually prefer junk bonds over bank financing or traditional Eurobonds to fund long-term growth plans. Banking systems in developing countries tend to be inefficient and unreliable, and Eurobonds carry maturities of from 3 to 7 years, compared with 8 to 10 years or more for junk issues. "In some emerging markets, corporate growth is outstripping the ability of banks to fund it," says Seth P. Bernstein, a J.P. Morgan & Co. managing director.
Global junk is attracting plenty of investors, about half of whom are U.S. mutual funds. Bankers say overseas issuers are actually in better financial shape than similarly rated U.S. companies. Adalberto Vianna, chief executive officer of Sao Paulo-based NetSat, says he isn't worried about the company's ability to repay its debt, which was raised by a Merrill Lynch-led syndicate: "We don't need tremendous economic growth for [the venture] to work."
Yet overseas high-yield securities are rated lower by major U.S. rating agencies because their ratings generally can't exceed the so-called "sovereign cap" of their home country. A BB-rated foreign company is likely to boast debt-service ratios that would earn it a BBB rating if it were a U.S. company, says Rick Johnston, managing director of OFFITBANK, an investment management firm. As a result, these securities, most of which are initially offered as private placements and then registered with the Securities & Exchange Commission, typically trade at just 25 to 150 basis points over comparable U.S. junk issues. Since 1993, they have generated average annual total returns of about 28%, compared with about 22% for U.S. issues. Says Johnston: "We're looking for world-class companies with bad addresses."
These securities aren't risk-free. Currency devaluations could jeopardize repayment. If markets turn sour, it may be hard for investors to find buyers. Regulatory risk is also a worry. About 40% of all issuers are media and telecom companies, whose prospects fluctuate with local rule changes. Some junk buyers, like Hari N. Hariharan, a managing director at Banco Santander's New York asset management unit, say that lately "some froth" has gotten into the market.
Within five years, more than half of all junk issues will be for foreign companies, compared with just 15% in 1996, says William Kourakos, head of global high-yield capital markets at Morgan Stanley. But if the U.S. experience is any indication, investors had better be prepared for some indigestion.