Junk Bonds and the M & A Craze

The merger mania is back now even at a higher level than during the days of Michael Milliken and junk bond mania. Of course, a lot of investors got severely burned when large parts of the junk bond market crashed in the late 1980s. Now junk bonds are back. There is a chase for higher and higher bond yields and may the risks be damned.

Already, the KKR deal earlier this year to buy up HCA (Hospitals,etc.) is bigger than the buyout of RJ Nabisco. In a deal like that, some 20 to 30 percent is raised in the equity market and the rest is grabbed through the sales of junk bonds. So, the question is, who are these high flying investors buying risky junk bonds at high interest rates, but no security except a plan to buy up a company, and perhaps immediately divide it up and sell it off, to make a profit? We really can’t say at this point except for the usual players: hedge funds looking to park money in a deal, make a profit and sell it off; equity funds looking to do the same; pension funds able to ride out the deal for a longer cycle, and the other usual suspects.

The default rate continues to be fairly low, but it could go up fairly rapidly. In 2001, when the tech boom and NASDAQ went bust, there was an overall default rate of 10 percent, so it has happened before, and certainly can happen again. It can be a bit scary, because companies are financing themselves at high interest rates. Tech start-ups can be financing themselves at bond rates as high as 17 percent. That is into the loan shark range. Many restaurants and construction companies are paying 10 percent or more. These high interest rates, or usury rates are an added expense in the overall economy.

This is continuing to accelerate. The latest deal over Thanksgiving 2006, is that the Blackstone Group is buying Sam Zell’s Equity Office Property Trust for $36 billion. This is certainly a big gamble, with the problems in the real estate sector, and the whole issue of their effects on the white collar employment sector. With problems in the automotive sector, the machine tool sector and the utopian fantasies of globalization, rocky water is ahead. Can workers making $1 an hour in Mexico, or a $1 a day in Bangladesh really substitute for skilled workers in the advanced sector? Don’t believe it.

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Adam Heist has been writing on the internet for many years now. Adam currently works day and night on his website home loans. For more information on this topic please visit his website today.

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