Four Safe-ish Harbors in a Sea of Debt

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Early last month Warren Buffett said government bonds are a terrible investment right now because they pose a substantial risk of imploding when interest rates inevitably start to rise again. This warning, repeatedly voiced by others as well over the years, can’t be taken lightly. But the truth is that most anyone who has sold their portfolio of government bonds until now has regretted it.

Continuing market uncertainty for nearly five years has kept Israeli government bonds on a nonstop ascent. Since late 2008, bonds issued by the treasury have produced cumulative returns averaging over 30%.

But Buffett is not the only one who has expressed concern that government debt, traditionally considered among the safest investments of them all, is actually fraught with considerable risk. There’s no need to imagine an apocalyptic scenario, such as the Israeli or U.S. government declaring insolvency. A change in market direction would be sufficient.

Those still interested in investing in debt could shift their gaze toward corporate debt but would quickly discover that whatever potential there is in that segment has already been heavily tapped.

“The market isn’t congenial towards bargain hunters,” says Shachar Rejwan, head of corporate bonds at Analyst Investment House. “Mutual funds are raising plenty of money and the market right now is high. Even if you have your hand on something that seems like a bargain, in all likelihood you’ll soon discover you bought it at too high a price.”

Danny Yardeni, mutual fund manager at Altshuler Shaham Investment House, agrees that Israel’s corporate bond market is priced high. “Spreads between corporate and government bonds are so thin that they can’t narrow by much,” he says. “In most cases the rise in bond prices doesn’t derive from any improvement in the financial condition of the issuers but mainly from the entry of new money into the market. This means the price isn’t justified.

“Corporate bonds are expensive enough that now’s the time to sell some and close out positions,” says Yardeni. “It’s sufficient that the public pull NIS 15 billion to NIS 20 billion out of Israeli mutual funds for spreads to widen between corporate and government bonds. At some point this will occur because that’s how things go.”

Yardeni says corporate bonds aren’t a safe haven for anyone concerned about the high prices of government bonds. “There can’t be any situation where there’s a catastrophe in government bonds without corporate bonds also suffering,” he asserts, explaining that in such a scenario it could be worse to be caught in the corporate market since government bonds are usually more liquid.

This isn’t bargain season. Bonds trading at high yields are always a gamble, and right now anything trading at a high yield to maturity must be treated with caution.

Nevertheless, here are four bonds that analysts have in their sights. None comes particularly cheap, and at any other period of time we would demand a higher return for investing in them.

Spacecom: Stellar investment?

Spacecom, one of the lesser-known holdings of Shaul Elovitch, the controlling shareholder of Bezeq, raised NIS 500 million in debt last month. Backed by cash flows generated by the company’s three communications satellites − Amos 1, Amos 3 and Amos 5 − the bonds offered a 5.6% annual yield as of the end of May.

But more importantly, security on the bonds includes a first lien on Amos 5 and second liens on Amos 1 and Amos 3 − not a trivial matter considering the company had Amos 5 alone appraised at a fair value of $278 million in February.

The space business doesn’t sound like one for widows and orphans to invest in, and Amos’ satellites have experienced malfunctions in the past, but Israeli telecommunications satellites are currently in demand. Spacecom’s revenues have been growing steadily − 62% overall since 2008 − to reach $86 million in 2012 with earnings before interest, taxes, depreciation and amortization ‏(EMITDA‏) of $53 million, representing 60% of turnover.

Mirland: Selling off

The bonds of Eliezer Fishman’s publicly traded real estate companies − Jerusalem Economy, Darban Investments and Mirland Development − used to trade at double-digit yields that signaled expectations that they could one day slip into bankruptcy. But these days, Mirland’s Dalet series debt is trading at a yield of close to 6%. Like Fishman’s other property companies, Mirland has been aggressively unloading assets.

Mirland’s financial reports indicate that its strategy of continuous asset sales conducted over a lengthy period helped it offload properties at favorable prices despite the knife held at its throat. Since the beginning of 2012 Fishman’s companies have realized NIS 3 billion from the sale of assets and raised about NIS 1 billion from the banks, insurance companies and the public.

“Fishman’s situation is better than ever,” says Yardeni. “He acted correctly and intelligently,” he said, noting that most of the yields on Fishman’s bonds have now fallen to the range of 2% to 3%.

Rosebud Real Estate: Trust the owners

In Rosebud’s case it can be said that buying and holding its bonds could only be in deference to the company’s controlling owners, David Weissman and Shraga Biran. The real estate firm raised hundreds of million of shekels in 2006 and invested the money in properties in Eastern Europe, France, Germany and Switzerland.

The company has long been tagged with a “going concern” warning and doesn’t have the means to repay its debts. But over the past three years, Weissman and Biran have repeatedly loaned the company some NIS 200 million, enough to meet its obligations. After investing so much, it doesn’t seem likely the two will suddenly stop propping up Rosebud, which would muddy their reputations in the process.

So for anyone willing to put their trust in the company’s two controlling shareholders, a 16% yield on its bonds might appear attractive.

Discount Investment: Recovered

Until about five years ago, when Nochi Dankner’s IDB group companies were issuing bonds in reams, they were considered one of the safest corporate debt investments available. The situation nowadays, amid failed business dealings and debt restructurings, is decidedly different, and the bonds of the holding companies − among them Discount Investment − sitting atop the group’s pyramid-shaped ownership structure are damaged goods.

But considering the enormity of the group’s tradable debt, they are continually being evaluated by investors scouting out new opportunities. Indeed, in recent weeks Discount Investment Corporation bonds trading at 8% yields have attracted much attention.

The reason is that shares of the operating companies held by Discount − Super-Sol, Cellcom, Property and Building Corporation and Koor Industries − have recently risen enough to swing Discount Investment’s balance sheet around from net liabilities to the point where its assets now exceed them by about 25%.

In addition, the company might receive a NIS 1 billion dividend from Koor within the next two quarters from the sale of its remaining stake in agro-chemicals company Makhteshim Agan or from selling shares in Credit Suisse, either of which would solve its liquidity crisis. However, the interests of Koor bondholders, too, might need to be taken into account, and this could throw a wrench into the works.

In any case, taking a gamble on Discount Investment will require keeping a close eye on the value of its subsidiaries’ shares.

Safe harbor in a stormy sea of sagging corporate debt?Credit: AP
Eliezer FishmanCredit: Ofer Vaknin
Nochi Dankner Credit: Tal Shahar

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