Investors in Apple’s record U.S. $17 billion bond deal have suffered some of the biggest losses in recent investment-grade new issues, with about $760 million wiped off the value of longer-maturing Apple securities that they bought just weeks ago.
The prices of the Apple $5.5 billion 2.4 percent 10-year and the $3 billion 3.85 percent 30-year bonds have plunged so much since the deal priced on April 30 that it would take about three years of earned interest from the coupons for investors to cover their losses.
“Basically if you own this paper, you’re sitting on it for three years or selling at a loss,” said Rajeev Sharma, senior portfolio manager at First Investors Management, who bailed out of his position in the 10-year at a loss some weeks ago.
The staggering losses are a painful lesson to the vast number of unhedged total return investors that it takes more than just being comfortable with credit risk to play in the corporate bond markets.
The 10-year note was trading on Thursday at $92.50, close to 7.5 points lower than where it was issued. At 95 basis points over Treasuries, its yield spread has widened 20 basis points from the 75 basis points at issue.
The 30-year has suffered even more, with a more than 12-point loss in dollar price. It was quoted at $87.60 and at a spread of 110 basis points, or 10 basis points wider than its 100-basis points level at launch.
“This deal is great for shareholders because of the tight coupons Apple locked in to pay for dividends and share buybacks, but everyone who didn’t hedge out rate risk – the Moms and Pops who have money in total-return funds – are looking at dollar losses that will suck up a lot of coupon payments,” said one senior manager of a bond syndicate desk who was not involved in underwriting the deal.
Apple attracted a record 2,000 orders worth $50.2 billion from 900 investors when it made its debut in the bond markets in late April, when the 10-year Treasury rate was 1.67 percent versus 2.4 percent today.
“This is not Apple’s fault,” said the senior manager. “It’s a fantastic credit. This deal could not have been better timed or executed in terms of pricing. And in terms of credit spreads, it’s widened out – but not by as much as many other names in its sector.”
One of few big technology companies with no debt on its books, Apple came to the bond market to raise funds for a $100 billion capital reward for shareholders, including a $60 billion share buyback over the next few years.
The company, under pressure from activist shareholders, chose to issue bonds because borrowing rates were low — and to avoid the U.S. corporate taxes that would be levied if it repatriated its offshore cash pile.
The spike in interest rates is the main factor behind the poor performance of the Apple bonds, although they are also a victim of the size of the trade.
The bigger the size, the more liquid the name – and the easier it is for mutual funds to finance redemptions by liquidating their Apple bonds. “It seems many investors who bought the longer-dated tranches didn’t realize that they were essentially buying rate risk,” said a senior portfolio manager of a total return fund. “We bought the floating-rate notes, because there wasn’t enough coupon to cushion against the risk of rising rates.”
At the same time, a proper market has yet to materialize for credit default swaps offering protection on Apple bonds. Although activity has picked up since the bonds priced, CDS remains illiquid and actual quotes and pricings are sparse.
Investors continue to be reluctant to make a market in any maturity other than the five-year, and the spread remains range-bound where the indicative mid-point was originally derived at 25 basis points.
That has surprised some who cautioned from the outset that the 30-year maturity was a surprising one for a technology name, given the uncertain lifecycle of companies in that sector.
They said the view of Apple as cash-rich and liquid, an innovator that will produce must-have products for generations, may have blinded some investors to the risk.
Apple may now face a more reticent investor base if it returns to the bond market for more cash to fund the shareholder program. “It’s unfortunate because this name had so much traction,” said Sharma.
“It really had a lot of investors waiting for it and the book was the largest ever seen. But there was no follow through (in terms of spread tightening after launch) – and you would expect that when a deal is 15 times over-subscribed.”
The 10-year and the 30-year did tighten and trade around launch spread after its pricing, but have essentially been underwater for the bulk of the time since then.