Opinion

James Saft

SAFT ON WEALTH: Rwanda, iBonds and the madness of the bond market

May 1, 2013

May 1 (Reuters) – In the past week we’ve had two object
lessons in the madness of the bond market: Rwanda and Apple.

Apple Inc, maker of the ubiquitous iPhone and iPad,
on Tuesday sold $17 billion of bonds, the largest-ever corporate
issue, at rates of interest barely discernible with the naked
eye.

Also recently, Rwanda issued a debut $400 million Eurobond
in a sale that was heavily oversubscribed. As the
market has taken to calling Apple’s issue iBonds, you could
easily call Rwanda’s 10-year offering aidBonds, as foreign aid
is one of the largest sources of government revenue for the tiny
African country.

While Apple and Rwanda are at different ends of the risk
spectrum, both deals neatly illustrate the headlong rush for
anything investable and carrying something vaguely resembling an
interest rate.

FRUIT OF THE TECHNOLOGY TREE

Apple’s historic deal, its first since 1994, was priced
closer to what a AAA borrower would pay, rather than a AA+
company with a dominant position in the turbulent tech sector. A
$5.5 billion 10-year piece yields 2.45 percent, while three
years gets you 0.511 percent, five years 1.076 percent and
30-years just 3.883 percent. Demand was stratospheric, with
offers to subscribe totaling more than $50 billion.

For purposes of comparison, a 30-year U.S. Treasury bond
yields 2.83 percent. The U.S. Treasury, while not possessed of
the design savvy or cache of Apple, has access to something a
lot more useful – a theoretically endless and costless supply of
dollars the government can create to meet its obligations.

Apple, with more than $140 billion in cash on its balance
sheet, was motivated to do the deal by tax concerns. Borrowing
will allow Apple to buy back shares and pay dividends while
limiting the tax hit it would take on repatriating cash held
outside the United States.

The question with Apple, surely, isn’t “Will you get your
money back?” but instead, “Could you be paid better for the
quite small risk that you won’t get paid back?”

This is where that 30-year bond looks especially foolish for
investors.

Remember BlackBerry? The communication device’s fall from
grace after Apple and other competitors entered the market is an
object lesson in exactly how quickly the fortunes of tech
companies can change.

Or look back 30 years ago to the Apple of that day. You
could make a case that the Apple of 1983 was International
Business Machines Corp, then a pillar of the stock
market which had carried a AAA ratings since its first public
debt issue in 1979. IBM is still a strong and vibrant company,
but bond investors might remember that it was stripped of its
AAA rating in 1992 and has been buffeted by competition and the
ever-changing tech landscape.

Yes, there are major difference between the companies and
no, Apple is not likely to go the way of BlackBerry. But if
Apple suffers only a modest setback in one of its markets, its
bonds might easily look woefully underpriced in a couple of
years.

RWANDAN YIELD

Rwanda’s deal, which was also heavily over-subscribed, runs
for 10 years and carries a 6.875 percent yield, as well as a
junk-level debt rating of single B.

While Rwanda has been growing impressively in recent years -
at about an 8 percent clip – this is a small, agrarian country
with a history of civil strife and a massive dependence on
external aid.

Not only does aid make up 38 percent of government spending,
it accounts for 10 percent of GDP. Remember, this is a dollar
bond and Rwanda cannot print dollars, but only earn, borrow or
solicit them.

In fact, of the foreign currency flowing into Rwanda last
year, 49 percent fell under the category of “current transfers,”
meaning it was mostly aid and remittances of Rwandans working
abroad.

While one can only hope for success and prosperity for
Rwanda, it seems to me that this is a very long and low-yielding
deal with multiple potential points of failure.

So why are we here? Why are investors willing to bet that
history won’t repeat itself for Rwanda but will for Apple? In
short, because central banks are creating conditions in which
investors stretch for yield but cannot create the growth that
will allow them to make decent long-term returns overall.

The main determinant of Apple’s yield is Treasury yields,
and those have been driven lower by central bank buying, which
has also freed up private money that needs a home and still
wants to hit its return benchmarks.

Likewise, Rwanda, which competes in a global marketplace
without many high-yielding instruments and thus can lock up 10-
year money at a very attractive price.

While risk management means that investors probably cannot
abandon the bond market, even in its moment of madness, they
should remember that 10 years is a long time in emerging
markets, and 30 years an eternity in technology.

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