Bond Buybacks: Good for the Goose - Good for the Gander?

Vadim Sviderski
Lior Zeno
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Vadim Sviderski
Lior Zeno

Plunging Israeli corporate bonds prices have already begun enticing controlling owners of public corporations: Over the past several weeks, many have been amassing bonds tossed away by the public at bargain prices - tens of millions of shekels worth. The trend is expected to continue, and even strengthen if bond prices continue falling. Many companies are already preparing themselves for such a scenario.

The sharp descent in rates on the Tel Aviv Stock Exchange began at the end of July, escalating during the week of August 7 to 11, when, over just four days of trading, the Tel-Bond 60 index, comprising the 60 most senior and high volume bond series on the TASE, fell 4.5%. Last week, the index experienced a 2.7% recovery, but this failed to shore up the bonds of smaller companies.

CasinoCredit: Bloomberg

Following the general drop in prices, some 35 companies began repurchasing their own debt. The total amount has now reached about NIS 115 million, but intentions have already been declared for this to reach a much higher sum - around NIS 900 million.

Buying back bonds at low prices instantly lowers corporate debt and leverage, and companies doing this can reduce their future financial expenses while posting capital gains (subject to certain accounting rules ). This activity, however, can't be performed automatically, as spending cash to buy bonds reduces a company's liquidity. The buyback decision is generally made based on a comparison of the bond's trading price and its adjusted value: The transaction is usually worthwhile if the bond is trading at a deep discount, like 20% below its adjusted value.

If, for example, a company owes its bondholders NIS 10 million and can buy back the entire bond series on the market for NIS 8 million, it can then post a NIS 2 million profit. It would still need to use up NIS 8 million of its cash resources; but at the same time, it erases NIS 10 million in future liabilities. As soon as the market improves, the company will likely be able to reissue the debt on easier terms.

Memories of 2008

The last time massive bond purchases were made by public corporations was during the market crisis at the end of 2008: A large number of Israeli companies, particularly in the real estate sector, tried taking advantage of circumstances to reduce their debts to bondholders. According to TASE figures, about 200 companies spent about NIS 3.1 billion buying back bonds totaling NIS 5.3 billion in par value that year, at an average face value discount of 41%.

About 43% of these were purchased by the companies that had issued them and removed them from trading, with the balance bought by their subsidiaries. Buybacks through subsidiary companies don't necessitate the removal of bonds from trading: These can be resold later on the market at a profit.

The current trend in the Israeli market pales in comparison with what happened in 2008, and bond buybacks since the beginning of August have been at a much higher average price level - about NIS 0.97 for each NIS 1.00 in par value. The gap from 2008 price levels is clearly the result of major differences between the two periods: The 2008 crisis was much deeper and spread over several months; the current crisis is still fresh, merely a few weeks old.

Among the purchasers are several companies that have been embroiled in problems for some time, like Ampal-American Israel Corp., since the Egyptian gas pipeline it partially owns was blown up, and Queenco, the operator of a casino and hotels in Greece, a country in deep recession and serious financial difficulties. These two companies recently repurchased their bonds at around 55 to 65 agorot.

Jerusalem Economy Corp. controlling owner Eliezer Fishman has experience galore buying back bonds. The company repurchased massive quantities in the 2008 crisis at 50 to 60 agorot apiece, joined later by other Fishman group companies like Industrial Building Corp. In 2009, JEC bought back about NIS 80 million of its own bonds, mostly in series B5, which regained 180% in value that year.

Fishman is also trying to capitalize on the current crash: Since the beginning of the month, IBC has repurchased a total of NIS 5.8 million in its series B8, B9 and B13 bonds. Fishman tends to repurchase his bonds through subsidiary companies, not the issuing companies themselves. This gives him the opportunity to resell them in the future and "play" with his companies' debt - profiting both when the markets collapse and on reselling after they recover.

Eli Elezra, owner of the Albar Mimunit Services leasing company, has been using a similar ploy: Albar recently spent NIS 25 million buying back its own debt at an average of 90 agorot.

Small companies leading the way

One notable aspect of the buybacks is the heavy involvement in this activity by small companies. Large companies participate too, but most purchases are by second-tier companies not featured in the stock market's leading indices.

This was also notable in 2008, when 89% of all companies performing buybacks were from among the "Yeter" (non-benchmark ) indices. Also prominently involved are several companies without stocks listed for trading, appearing on the board only because of bonds they've publicly issued.

Thus by the second day of the Tel Aviv stock market plunge, the board of directors of privately-owned Club 365 adopted a NIS 20 million bond buyback plan over a year, explaining: "The bonds are trading on the market at a significantly lower price than their adjusted value, and we view their purchase as a good alternative investment."

The announcement followed the firm's B2 bond series dropping 13% in value the same day.

Gil Deutsch and Roni Biram, former owners of Excellence Investments, were also quick to lead their energy company, Sunflower Sustainable Investments, into a NIS 2.3 million repurchase of its series B4 bonds.

There are several reasons why most of the current bond buybacks are by smaller companies. First, the bonds of a number of these companies have experienced particularly sharp drops, so the opportunities presented are greater. Mounting redemptions in bond-based mutual funds - several billions of shekels over the past two weeks - is likely the main reason for the sharply falling prices of small company bonds with limited trading volumes, with pressure on the funds to unload them at almost any price.

A second reason is that smaller companies are often more adept at reaching decisions quickly and acting on them. For a large company, a NIS 2 million or NIS 3 million profit might be relatively less significant than for a small company, making a sizable contribution to business results over the span of an entire year.

Debt repurchases by controlling interests can often provide an important signal for anyone tending to invest in bonds. A company that decides to spend its cash buying its own bonds transmits a message to the market that it has the means to redeem its debt. It also reduces its total debt load, making it easier to redeem the balance in the future. Anyone identifying such a pattern of activity should feel more secure buying the bonds of such a company in the market.