Be Wary of Dell’s Unusually High Bond Yields

The Financial LexiconIn today’s ultra-low-interest-rate environment, A2/A- rated corporate debt with yields as high 6.834% may seem like a no-brainer investment.  With that in mind, investors may be tempted to purchase any of the following A2/A- rated Dell bonds:

CUSIP 24702RAF8, maturing 4/15/2038 with a 6.50% coupon and asking 96 cents on the dollar (6.834% yield to maturity).

CUSIP 247025AE9, maturing 4/15/2028 with a 7.10% coupon and asking 104.25 cents on the dollar (6.65% yield to maturity).

CUSIP 24702RAM3, maturing 9/10/2040 with a 5.40% coupon and asking 86.25 cents on the dollar (6.475% yield to maturity).

CUSIP 24702RAJ0, maturing 6/15/2019 with a 5.875% coupon and asking 103.375 cents on the dollar (5.244% yield to maturity).

CUSIP 24702RAQ4, maturing 4/1/2021 with a 4.625% coupon and asking 96.00 cents on the dollar (5.232% yield to maturity).

CUSIP 24702RAE1, maturing 4/15/2018 with a 5.65% coupon and asking 103.516 cents on the dollar (4.876% yield to maturity).

Clearly, in today’s interest-rate environment, an A2/A- corporate bond rating does not warrant yields as high as those of the six Dell bonds listed above.  So why do Dell’s bonds have such high yields?  Earlier in January, rumors surfaced of Dell being the target of a possible leveraged buyout.  When that occurred, the stock soared, and the bonds got crushed.  Leveraged buyouts and weak covenant protections on bonds are two things that fixed income investors are not fond of.  And Dell’s bond investors are showing their displeasure. 

If you are considering adding Dell bonds to your portfolio, keep in mind that in the event of a leveraged buyout, leverage ratios will increase.  The market may already be pricing this in (and pricing in several notch downgrades), but it is important to remember that the current data you will find when doing due diligence on Dell’s financial profile will change once private equity gets its hands on the company.  This does not necessarily mean the bonds are not worth buying and will one day be defaulted on.  It simply means that the risk profile of owning the bonds has changed.

Additionally, if you think the buyout rumors are nothing more than rumors that will never come to fruition, there is likely an opportunity for some solid gains in the bonds (higher prices/lower yields) once the rumors are proven to be false (if that is indeed what occurs).

Last, if you are an investor who wants to invest in Dell but will no longer be able to do so through the stock once the buyout rumors turn into reality (if that is indeed what occurs), then the bonds are likely your only alternative.  In that case, you might end up viewing the recent selloff in the bonds as a gift.  After all, you can now get bond yields more than double the dividend yield of the stock (even at the price the stock was trading pre-buyout rumors).  A leveraged Dell that still pays on its bonds might turn out to be a better investment than the stock would have been had the company never been purchased (if the company ends up being purchased).

 

More from The Financial Lexicon:
Income Investing Insider Newsletter

The 5 Fundamentals of Building a Retirement Portfolio

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