Naples Florida Weekly
Loading...

Low interest on Walmart bonds not worthy of investment

MONEY & INVESTING



 

 

What do you do if you need a few extra bucks and don’t have the money? If it is a small purchase, you may put it on your credit card. If it is something larger, you may have to go to the bank and get a loan. But what if you are a business and need more than a few extra bucks? What if you need $16 billion — what do you do then? Walmart recently faced this problem after its acquisition of the Indian E-commerce company Flipkart Group. The solution was to issue corporate bonds to the public in return for the cash needed to fund the purchase. But just what are corporate bonds, how are they priced and issued, and are they a good investment?

A bond is simply an investment where the investor loans money to a borrower in exchange for a set interest rate for a given period of time. At the bond’s maturity, the investor receives the principal back as well. For bonds issued by corporations, typically interest is paid every six months although some bonds pay quarterly or monthly interest payments. Corporations issue bonds that mature anywhere from less than a year (this debt is often called commercial paper) to 30 years or more. Large companies like Disney or Coca-Cola have even issued 100-year maturity bonds.

 

 

To issue a bond, a company typically will meet with a bank or investment bank to structure the investment. First, the parties will determine the size of the bond. If the company borrows too much, it may hurt its credit rating or have trouble making the interest payments. If it borrows too little, the borrower may not have the funds to maximize its growth or business opportunities. Second, the company and bank will determine the appropriate maturity for the bonds. Factors such as the use of the funds, overall interest rate environment, and credit worthiness of the borrower all will affect this decision.

Finally, the bank will price the bonds. Most bonds are issued at par meaning they are issued at the face value of the bond, often $1,000. The “price” of the bond is then the interest rate that the buyer of the bond will receive. For example, a company can issue a 10 year bond at par that is priced at an interest rate of 6.2 percent. The interest rate of a corporate bond is determined by two factors. The first is the overall rate environment, typically determined by U.S. government debt rates. The second is the credit worthiness of the issuer, which determines the additional interest that investors demand to hold the bonds over Treasury rates. This “spread” can be very small for well capitalized and stable companies like Microsoft or Apple or very large for risky biotech firms.

After the interest rate of the bonds is set, the investments are sold to the public at the face value of the bonds. Going forward, however, the bonds will trade on the open market and will either trade at a premium or discount to the face value. If overall interest rates go up or the credit worthiness of the company declines, the bond’s value will decline as investors sell the bonds to buy more stable bonds or bonds with higher interest rates. Conversely, if interest rates decline or the company credit strengthens, the bonds’ value will rise as investors buy the bond.

In the case of Walmart, several maturities of bonds were offered to investors to fund the staggering $16 billion needed to fund its acquisition. The longest dated bonds, 30 years to maturity, were priced at just 1.05 percent over the 30 year Treasury rate or around 4.1 percent. This very low rate speaks very highly of the credit worthiness of Walmart. However, one of the main bond credit ratings companies, S&P, stated that the company’s strong AA credit rating may be placed under review because of the significant acquisitions the company has recently made and the resulting debt issued to pay for them. Therefore, I would be hesitant to tie up my money for 30 years at such a low interest rate and feel that there are plenty of better investments to earn a better risk adjusted return. ¦

— Eric Bretan, the co- owner of Rick’s Estate & Jewelry Buyers in Punta Gorda, was a senior derivatives marketer and investment banker for more than 15 years at several global banks.

Leave a Reply

Your email address will not be published. Required fields are marked *