“Lock in” Gains with “Minimum Notes” — True Income

By Travis Johnson, Stock Gumshoe, February 19, 2009

Quite a number of you have sent notes to me about these, um, notes lately — if you’re on many of the newsletter or financial mailing lists you’ve probably seen them, too. This is a teaser that promises …

Buy this investment today and “lock in” a minimum gain of 244% (It could possibly even return
as much as 1,002%)”

It’s also making the rounds under the headline, “What is 2008’s best investor buying now” — a reference to John Paulson, who apparently calls this type of investment a “$10 trillion opportunity.”

Sound familiar? Yes, you’re right — we’ve looked at this one before, little has changed except the name that they’re giving to this investment, but there were some additional specific recommendations in the ad so I thought I’d take a quick look for you.

First of all, what are these “Minimum Notes” that they’re telling us are being recommended by Jeff Clark for his True Income service? They are, as far as I can tell, exactly the same thing as the “Mega Bonds” this same service was teasing us about a couple weeks ago. Truth be told, I do like the name “minimum notes” better, seems more appopriate for our times … but really, the name I like best is the real one, “convertible bonds.”

Convertibles are just what they sound like, bonds that can (or sometimes must) be converted to equity according to whatever the specific terms of a possible conversion are (just about every bond is different). They’ve been getting a lot of attention lately because they offer the stability of bonds and a set coupon payment, and the possible participation in the upside of a stock if the underlying company performs well or the market rallies significantly. If you want more information about convertibles in general, you can read my earlier, long winded discussion of “mega bonds” here, or, for a similar teaser from Justice Litle, my discussion of a closed end fund that holds convertible bonds here.

(Justice called them “Crisis Bonds,” by the way — so what’s your favorite term: Crisis Bonds, Mega Bonds, or Minimum Notes? We can have our own little marketing focus group right here.)

I know that many publishers are pushing a corporate bond strategy with at least one of their newsletters, and that corporate bonds of all types, including convertibles, have become the “it” investment over the past month or so … so it may well be that you’ll find some protection in bonds and their set coupon payments and promise of principal repayment, or that they will offer considerably more stability than equities, as they typically have in past years. I don’t really know what will happen, of course. I’m sympathetic to the argument that everyone should hold bonds as well as equities, an argument that probably was shouted down too aggressively by most financial pundits over the last 15 years as individual stock market investing became fun, easy, and popular for a whole new class of investors … but on the other hand, I haven’t personally bought any bonds and I’m not sure I know how to analyze them effectively.

I do know that in the original Mega Bond article I told you about two specific convertible bonds that Mike Williams appeared to be “teasing” as current recommendations of his True Income service, and as I read through this new version of the teaser I saw clues for a couple more that I thought I might share with you. Let’s have a look …

These are both based on a $10,000 investment, which at face value would usually be ten $1,000 bonds, but on the secondary market most corporate and convertible bonds probably trade at a discount to their principal value at the moment. Here’s what they say you could make:

“One of the world’s largest semiconductor companies offers to pay you a 455% return on December 15, 2016, in addition to a $2,812 income check every six months…”

OK, so this one is a guess: sounds to me like it could be ON Semiconductor (ticker ONNN). This is a decent sized semiconductor company, market cap of $1.5 billion or so. They have a convertible bond that matures on December 15, 2026, but bondholders can require the company to pay back their principal on several dates before then, including December 15, 2013 and December 15, 2016. The conversion rate is something like 95 shares per $1,000 principal value of the bond, and you can convert beginning in June of 2013 if you like (wouldn’t be worth it now, by a long shot — the shares are at $3.75, the bond is trading at about $65 right now per $100 of principal (so $650 per $1,000).

This could easily not be a match, I’m not sure — the teaser says that a $10,000 investment gets $5,600+ in interest payments annually, which is ludicrous (that’s 56% interest, unless I’m really having math problems), so I’m assuming that either this bond is laughably low grade, or that they scooched the decimal point over by mistake. If they scooched the decimal point, this could be a match with interest income of something like 5.6% a year and, if you assume that the stock will recover in the next seven years (or even four years), a potential return much greater than that or a potential return of about 50% if you just call the bond and get your principal back in a few years instead of converting.

Again, let me be clear that I don’t know if this is a match, and I personally know absolutely nothing about ON Semiconductor, this is just a semiconductor company with a convertible bond that could plausibly match the clues.

Can we do any better on the second one?

“The world’s largest private-label beverage company is legally obligated to pay you a 61% return on December 15, 2011… and interest payments of $1,288 a year …”

Well, as long as we’re talking about soft drinks the world’s largest private-label beverage company is Cott (ticker COT), and they do indeed have a bond that matures on December 15, 2011. Of course, as far as the company is concerned, that’s part of the problem — the shares trade as if they’re on the verge of bankruptcy, the market cap is only about $50 million versus a debt load of about $440 million, and the shares change hands for less than a dollar right now.

I have no idea whether or not they’ll be able to remain current on their debt payments and stay solvent, but bondholders are clearly at least a bit nervous — the bonds trade at about $56 per $100 of principal, and the ratings agencies give them ratings in the C range — Caa2 and CCC. You may or may not have much faith in the ratings agencies, and I wouldn’t blame you for being skeptical of them, but that ain’t good — in one description of credit ratings I’ve seen (from S&P, which issued that CCC rating for COTT), this is how they describe this rating:

“indicates a current identifiable vulnerability to default and is dependent upon favorable business, financial and economic conditions to meet timely payment of interest and repayment of principal. In the event of adverse business, financial or economic conditions, it is not likely to have the capacity to pay interest and repay principal.”

So, this bond seems a pretty likely match for the teaser, and you do theoretically get that guaranteed return of principal, but the company’s not currently profitable and the price the bond is fetching on the secondary market is telling you that many professional investors think there’s a good chance that Cott will default, and they’re not sure the company has enough assets for them to trickle down to these bondholders and pay off the principal if that happens.

So there you have it — more info on corporate bonds and convertibles, just in case you’re curious. We’ve had one review of the True Income service over at the reviews site so far, so please jump in and add your opinion there if you’ve subscribed to this service (from what I hear they’ve had a rough year, but that doesn’t necessarily mean the strategy or the newsletter can’t be promising in the future).

Or if you’re just interested in income in general, check out the Income Newsletters section of the review site and see if there’s anything you like there — or anything you’ve subscribed to before on which you can share an opinion to help the rest of us … thanks!

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