The author is a fixed income portfolio manager at Barksdale Investment Management and co-author of “Udiversified: The Big Gender Short in Investment Management”.
The collapse of some of the stock bubble flag bearers over the last few years has been painful for investors. We have seen ‘pandemic winner’ Netflix fall 75% from its 2021 highs, cryptocurrency exchange operator Coinbase dive 86%, and former memes and movie channel AMC lose 80%.
Less noticeable are the losses on their bonds. The damages are more moderate and offset by coupon payments – a Netflix bond maturing in 2030 has yielded a negative 19% from recent peaks, a Coinbase 2031 bond negative 36% and an AMC bond 2026 a negative 19%. This is partly due to the very different capital structures in the individual companies and the risks of bonds versus shares.
For hedge funds that benefit from arbitrage transactions between capital structures, such differences constitute a playing field full of opportunities. But the spreads also highlight the differences in ownership and return characteristics for equities versus bonds.
First, corporate bondholders are largely institutional, although most investment-grade issues are publicly registered. The publicly registered adverse bond is a species doomed to extinction as burdensome disclosure requirements and increased time-to-market drive companies toward private placements with institutions. While institutional investors can trade frequently, the concept of day trading and the associated increased volatility is largely a retail phenomenon in equities.
Second, while it is quite obvious to say that the return outlook is different for non-distressed bonds and equities, the calculations are a bit more nuanced.
Bondholders ‘, like shareholders’, risk of loss is unlimited if a company defaults (although in practice, unsecured creditors receive an average of 35 cents for every dollar invested in a defaulted company). But our advantage is limited. Bond documents typically contain a provision that a company can choose to redeem (or call) a bond before maturity and issue new debt at a lower interest rate, which means that the investor will not necessarily benefit greatly from an improved balance sheet.
This means that the soaring growth forecasts that have pushed Netflix, Coinbase and AMC stocks to their record high levels simply cannot be recognized in their liabilities. Creditors still suffer from misjudgments, but the tyranny of the bullpen saves us from ourselves when growth seems endless.
Finally, the performance of corporate bonds should be divided into total returns and excess returns. The latter refers to the return on the bond after comparing it with what investors could earn on “risk-free” government bonds with similar terms.
So what story does Netflix, Coinbase and AMC bonds tell? The “excess” interest rate on Netflix’s 2030 bond is about 7% negative from its peak in November. This means that more than half of its negative results are related to the bear market in US government bonds. Coinbase’s 2031 bond, on the other hand, had a negative excess return of 28% from November, compared to a negative excess return of 5 for its benchmark. AMC’s excess return from the peak in June 2021 was negative 14%.
The bond market seems relatively more comfortable with Netflix’s financial strength. Coinbase’s 2031 bond, on the other hand, reflects the skepticism that has prevailed since its issuance last September. Unusually, the bond traded almost immediately – although the stock and the Bloomberg Bitcoin Index did not peak until November. It is not necessarily that creditors were ahead of the game in predicting the latest crypto sale – on the contrary, we do not have the stock-like mindset needed for optimism of crypto integrated into Coinbase’s top levels.
Finally, AMC strengthened its financial position with capital increases as its shares exploded. But its bonds with a first mortgage or claim on the company’s assets are traded at a steep premium on debt versus a second mortgage. This suggests a constant concern about the company’s financial prospects.
Who knows where these companies’ bonds will be in a year? But the corporate crash raises questions about the logic of rules that allow individuals to buy Coinbase or AMC stocks, but not their unregistered bonds to “protect” unsophisticated investors.
Barksdale Investment Management may own shares in the said companies