Taking Stock / The Monk Who Sold You Bonds

And will be buying them back on the cheap. Ilan Ben-Dov isn't about to let a meltdown ruin his mojo.

"Explain to your writer who Ilan Ben-Dov is and what we're talking about," he begins. "She [the writer] looked at Tao Tsuot's financial statements, saw that some of the shares we bought with borrowed money had fallen, and ran to make a headline out of it. Tell her who Ben-Dov is. She may not know that I'm one of the most liquid businessmen in Israel."

That was two months ago, a few days before Tao Tsuot published its report for the year 2007. A few days earlier, a writer for TheMarker had looked at Tao's third-quarter report and did not need a supercomputer to work out that the company was going to present a bleak picture for the last quarter of the year. Hundreds of millions of shekels raised from bond issues on the stock market made the story not only spicy, but acutely relevant, too.

A little over a week ago, Tao published its report for the first quarter of 2008. It lost NIS 205 million, wiping out its shareholders' equity. The company's stock and bonds were hammered. Its bonds plunged by 50% to 70%.

So let us comply with Ben-Dov's request and explain who he is, what Tao Tsuot is, and how the method works.

Ben-Dov really is one of the richest and most liquid people in Israel. Fifteen years ago, he was a bitty importer of games and distributor of cell phones. He started to climb the business ladder in 1994 after floating his company on the Tel Aviv Stock Exchange during the merry bubble days.

His chance came a few years later: He began representing Samsung, importing phones and selling them to Pelephone for hundreds of millions of dollars, at a huge profit. And he became deeply spiritual. He saw the light, began to travel to India, had his picture taken in monkish poses and talks in soft tones about his new path.

1. Four years ago, Ben-Dov decided to use his wealth and good name in the marketplace to take over Yarden Investments. He bought it for peanuts from Roy Gill and Eitan Eldar, who had picked bad investments during the boom. The two had borrowed hundreds of millions of shekels from banks and investors, all of whom lost much of their money.

Ben-Dov changed Yarden's name to Tao Tsuot. Tsuot is Hebrew for "returns" - think capital gains. Tao, of course, means "the way" in Chinese. Taoism is, roughly speaking, a collection of philosophical and religious ideas based on "three jewels": compassion, moderation and humility (okay, I'm better at defining worldly debts than other-worldly ideals).

"Moderation" is not exactly the word to describe Tao Tsuot's activities from the time it arose from Yarden's ashes. Ben-Dov began a rapid series of fundraising campaigns and acquisitions. He bought up blocks of shares, companies and real estate projects from Eilat to Manhattan. Almost every stock he touched leaped like a Tibetan goat.

Somehow, The Way inspired appetite: Banks and investors showered him with more and more money for more and more investments, and by a year ago, the shattered remains of Yarden had turned into the giant Tao Tsuot, a company with a balance sheet of NIS 2 billion.

2. What happened then is more or less what happened to the young pair who had sold Yarden's remains to Ben-Dov: The stock market reversed. For Gill and Eldar, the dot.com bubble exploded, and so did the intifada. In 2007, it was the subprime crisis. The reason doesn't really matter; what does is that the real estate market cooled. Stocks Tao had bought collapsed, loans loomed large and shareholders' equity vanished. Investors started to dump Tao Tsuot's securities.

This is simple. Stay with us. Don't panic at the jargon. You'll get it.

Investors who bought into Tao Tsuot did not wait for the company's 2007 financial statement. They started dumping its bonds and stock a year ago. The result is that Tao's bonds are trading for less than half of their value when issued, or of their adjusted value - meaning, the value if they are repaid (capitalized to the present).

Which means what? That investors think the probability of Tao repaying its bondholders in full is very, very small. Tao bonds are trading at five times the yield of risk-free bonds (the kind investors are confident will be repaid, in time).

Which means what? First of all, that investors are not that impressed with the fact that Tao is controlled by Ilan Ben-Dov, the liquid millionaire, the monk who sold Samsung phones and bonds and who can afford a lot of Ferraris today. More importantly, it means Ben-Dov may never have to repay the money he borrowed from investors.

How's that? When Tao published its report last week, Ben-Dov signaled that the company may suggest that investors convert bonds into shares. It will not be paying them a sou, it will be issuing them shares in exchange for the bonds. And what about the money that investors hoped they would get, their investment plus interest? They will have to be patient.

What will happen in the end? It doesn't matter. In Taoism, what matters is the way, not the outcome. En route, Tao may be able to shake off that irksome duty to repay the principal and add interest.

How? Simple. When a company's debt is liquid, meaning traded on the stock market, it has a price. A company in Tao's situation is very likely to go bankrupt, and therefore, the price of its debt will plummet (who would pay for it?). Tao could have plenty of opportunities to buy back its bonds for a song.

Now for the simple part: The collapse of Tao's bonds could enable Ben-Dov to make a lot of the company's debt evaporate.

Why would investors agree? Because they look ahead, not backward. The bonds imploded and they want to cut their losses. Naturally, some may rebel, but then Ben-Dov could adopt another ploy: Sell Tao to a new investor, who will reach some kind of arrangement with the dismayed debt-holders.

Did Ben-Dov invent this system? Of course not. It has been done before. You borrow from the public, gamble the money, and if it works, terrific. If not? No biggie, buy back the worthless debt for peanuts or reach an agreement to return a fraction of the debt. At worst, when matters get seriously embarrassing, sell the company. The buyer will not have egg on his face; he's new. What do you want from his life? He's just there to fix things.

What does all this mean for investors? Simple. When you buy corporate bonds on the market, do not get all starry-eyed about its owner and his soaring liquidity. The richer he is, the more indifferent he may be to your pocket. The ones who generally have to repay every penny are those for whom the company is their whole life, and who will be blacklisted by the banks and the market if they default.

Just last week, it turned out that Bank Leumi had provisioned a quarter-billion shekels for debt from Tower Semiconductor. Who owns Tower? The Israel Corporation, in which Bank Leumi owns 18%. Bank Leumi is provisioning for a debt owed by a company belonging to the richest business group in the land, which is also its partner.

By the bye, the same Ofers who own The Israel Corporation also own Bank Mizrahi-Tefahot, where they also run into rich people who shrug and say, what debt? That's a company debt, not mine.

The rules of the game are that if you owe a mortgage or a small loan, you have to repay every penny and then some. The debt is your problem. If you play big and owe millions upon millions, it is the bank's problem, not yours. Sound unfair? Well, there is logic to it: That is what a "limited liability" company is all about, to distinguish between the company and its owners or shareholders. The firewall is breached only in case of embezzlement, or if the controlling shareholders choose to infuse money into the company when it is struggling. Without such a firewall, there would be no business.

So is all well? No. The rules of the game are clear after the fact. But when companies raise money from banks and investors, the lenders tend to forget that the owners are likely to leave the risk to the debt-holders. In market argot, they say the bondholders are not pricing risk properly.

And who are the bondholders? We all are, through the institutional investors managing our money. Don't their managers understand the rules? They do, but it is not their money, it is ours. And they are terribly busy wondering how to cross the road and be the ones selling the bonds, not buying them.