Mega Bonds: Closest thing to a perfect investment?

By Travis Johnson, Stock Gumshoe, February 9, 2009

Many of the delightful readers of Gumshoe Nation have sent in this ad, for the True Income service from Stansberry & Associates. As with so many ads these days, it teases us that, (if we’ll just subscribe and follow their advice), we can make tremendous profits with lower risk.

Here’s how it opens:

Can “Mega-Bond” #559211AC1 really pay a MINIMUM of 77% by Dec. 15th, 2009?

“Unlike any investment I’d heard of before, “Mega-Bonds” offer the security of regular bonds… with all the upside of stocks.”

I’ll give you the quick answer: Yes, it “can.” It may or may not, but it can.

So what is this Mega-Bond? And since we probably care about more than just #559211AC1, of what ilk is our strangely numbered friend?

I’m glad you asked.

Unlike previous teasers for this service, they actually “spill the beans” in the text of the letter about this particular “Mega-Bond” — it happens to be a bond issued by Magna Entertainment, which is big in the news for us in the DC area (and for the Stansberry folks in the Baltimore area) because they own some racetracks and they’re involved in trying to get licenses for the first legal slot machine parlors in Maryland.

They’re also not real popular, according to investors in their common stock — the shares (MECA) are at about 50 cents, steadily and sharply down from $100 in 2006 and about $20 about six months ago.

And that number for this “Mega-Bond,” 559211AC1, is what’s called a CUSIP number — that’s an identifying number that most securities traded on the after market have, sort of like a stock ticker that helps to make sure that all parties know you’re talking about the same thing when you buy and sell.

In this case, the bond is a convertible corporate bond, meaning it’s a loan to a corporation and, in some circumstances, the bondholders can convert their stake into equity and perhaps benefit from a rising stock price as a result. I wrote a bit about convertible bonds just last week, when Justice Litle at Oxford was calling them “Crisis Bonds,” so I won’t go into great depth on what they are today, but the general idea is fairly simple — you lend a company money, and they pay interest, just like with any bond, but if the common stock really takes off you might get some nice extra capital gains, too.

And in this case, as with most of the previous teasers we’ve seen from the True Income service, it’s very much a “junk” bond — which usually means that it’s rated as being below investment grade, and therefore at some greater risk of default, by the ratings agencies. That’s not technically the case here, but that’s because MECA is not rated by Moody’s, S&P or Fitch, probably because they’re small and broke and didn’t pay to be rated.

Still, I feel comfortable in calling it a “junk” convertible bond — the bond last traded for about $31 on a principal of $100, and it is due next December 15. So that means if the principal is to be repaid next winter as the firm is required to do, you’d get an automatic profit of about 200% just from that repayment. As you can imagine, that means investors don’t think they’re going to get all their principal back.

Now, in this particular case it’s quite a complicated bond, and a complicated situation, which is also part of the reason why the common stock of the company is so beaten down — Magna Entertainment is not just involved in a high stakes bid to build a slot machine parlor at one of its racetracks just outside the Capital Beltway, they’re also in the midst of a major restructuring that essentially looks like it will have them taken over by one of their major investors, according to the press releases I read. I don’t know how far along they are in this restructuring, so be quite careful and take anything I say here with at least a grain of salt.

There is some kind of provision for retiring this convertible debt before it expires, but I have no idea what the terms might be, or if they’ve even approached bondholders yet about possible terms. So if you’re actually interested in this particular convertible bond, I’d be very careful to read carefully — if this big restructuring is completed, it seems very unlikely that there will really be a “conversion” to equity, even if you assume that the equity will ever go up again, though I suppose it’s possible that the retirement of that debt might lead to a profit for debtholders at current prices — again, “possible,” I have no real idea.

The bond pays interest semiannually in the amount of $7.50 a year (the original bond was a 7.5% interest payer, on a $100 principal), so now the yield is about 25% — but according to the timing of their payments there are probably only two interest payments left, one sometime this summer and one at maturity. The bond can be called at any time after February 26 for $100, so that would really be the dream, to have your $30 bond called away for $100, but, thanks to this restructuring, I have even less of an idea than I would otherwise about whether or when this will happen.

The ad letter also tells us that “Mega Bonds” (can we call them convertible bonds now?) were the path to riches for some of the most famous investors we know …

“‘Mega-Bonds’ were kept secret by the world’s wealthiest investors, who used them to make an absolute killing.

“Warren Buffett, for instance, is famous for investing in value stocks.

“But what few people know is that ‘he made himself the world’s richest person thanks in part to [Mega-Bonds],’ says Tom Taulli of the USC’s Marshall School of Business. ‘That’s his preferred method of investing.’

“And Bill Gross, the legendary founder of PIMCO, wrote his Masters’ thesis on ‘Mega-Bonds.'”

If you’re curious about those two, the article that quotes Taulli about Buffett is here (from Entrepreneur magazine in 2004). And Gross did write a thesis about convertibles in graduate school, though I can’t imagine any of us would be excited to read it at the moment.

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I don’t have anything against convertible bonds, or against investing in the other high-yield corporate debt that Mike Williams and his publishers have teased before for his True Income service. Still, do keep in mind that corporate debt is the “in” investment right now — everyone is urging you to run to corporate bonds (admittedly, more people are probably pushing investment grade bonds, not high yield “junk” bonds or convertibles). That doesn’t mean it’s wrong to loan corporations money, but it does mean that you’re part of a crowd of folks who are all doing the same thing … which can mean that you end up overpaying.

If you’re interested in looking for any of the “Mega-Bonds” mentioned specifically in the ad, you can always just punch the CUSIP number or the company name and ticker into one of the bond search engines to see the basic details — this is what the description page looks like from FINRA for the Magna Entertainment convertible bond, and you can use their advanced search here to find others, or just enter CUSIP numbers at’s advanced search page to get some of the trading details.

But there’s more! Williams is apparently recommending some specific bonds to his subscribers right now, with a bit of teaser info about them, so let’s see if we can figure out what those are:

“A little-known network of hospitals has just issued a “Mega-Bond” that is due to pay a minimum 36% return on May 15, 2014. It also pays $489 each year in interest (assuming a $10,000 investment). But best of all, it could pay you 64% or more if the stock goes up…”

I can’t tell you for sure, because the best match I have doesn’t match that $489 coupon payment, but the most likely match for this one seems to be LifePoint — the basic info on this convertible bond is here, the CUSIP number is 53219LAH2 if you’d like to research it further.

It’s priced at about $73 for a $100 principal amount that is due on May 15, 2014, so you would get almost exactly a 36% return just by holding to maturity and getting your money back, even if you ignore the coupon payments. I haven’t checked to see what the convertible part of this offering might be (ie, what ratio or target price), but the bond is yielding about 10% right now and the company does not seem wildly indebted at a quick glance, and it’s currently profitable — this bond is rated B by S&P and Fitch, which means the financial situation “varies noticeably,” it’s two steps down from investment grade but is certainly better than the C rated bonds that are currently “vulnerable.”

“And the new “Mega-Bond” issued by a New Jersey-based supermarket chain is set to pay a minimum 72% on December 15, 2012… PLUS interest payments of $581 every six months… AND the potential to make as much as 110% if the stock price shoots up…”

This one, in all likelihood, is A&P — the Great Atlantic and Pacific Tea Company (GAP), one of the really great company names. People sometimes look to grocery stores as safe investment havens in a recession, since we’ve all got to eat, but A&P has been in trouble for many years — they do have a big ‘ol debt load, though they’ve also gotten bigger in the past year or so by buying Pathmark, so perhaps those improving sales will help them with economies of scale. They may well survive, I have no idea. The Fool recently ran an article about them being on “deathwatch,” which may or may not mean anything, and they have managed to survive for something like 150 years so far, which also doesn’t seem to mean much to the market gods in this particular enviromment. The bonds do trade for just under $60, with a massive yield so the return to maturity would be in the neighborhood of 72% on December 15, 2012, haven’t checked the conversion details for this one, either. It looks like the coupon payments would probably give you a yield of about 11.5%, but the yield to maturity would, of course, be much higher thanks to the fact that it trades at such a huge discount to the principal value.

If you’d like to see the details on the A&P bond, the basics are here — it’s CUSIP #390064AK9, just FYI.

I’m no real expert on bonds, or certainly on corporate debt specifically, but one of the reasons that people have been urging us to buy corporate bonds is because the “spread” has gotten so big that it’s out of whack and must shrink. When folks talk about the spread in this context, they mean the difference between “riskless” US treasury bonds and corporate bonds. Often the spread between treasury bonds and highly rated investment grade debt has been just a couple percentage points, or even less, but now it’s much larger. There are two ways for this to “revert to the mean” — either treasury bonds can go down in price (and get a higher yield), or corporate bonds can go up in price (and get a lower yield). Or both could happen simultaneously, of course.

I don’t know what the future will bring, but I think it’s worth arguing that, given the state of the economy right now, corporate bonds are at least fairly priced, and possibly overpriced — the large spread is not because people are irrationally afraid of corporate debt, it’s because people are irrationally lending their money to the US government at incredibly cheap rates.

If defaults go up significantly, as all the prognosticators seem to expect, then we should demand a much higher interest rate — and if highly leveraged companies go bankrupt during a period of asset deflation, and after years of relying on easy credit, it’s quite possible that many of them won’t have enough real assets to pay back their creditors.

And of course, the main reason that Treasury bonds are so cheap (though they’ve come back a bit already) is that us government bonds remain one of the few “safe” refuges from investment risk in the world — and because people see deflation, not inflation. If inflation comes back at any appreciable level, almost all kinds of bonds will probably be awful investments (with the possible exception of inflation protected bonds, and convertible bonds of companies that might thrive in inflationary times).

That’s not a prediction on my part, I don’t know if bonds will turn out to be good buys — or, for that matter, if Mike Williams and his True Income service will be able to dig into the numbers and pick the best low-grade debt for you to buy, from the companies that are most likely to be able to meet their obligations. I just know two things: Everyone’s suddenly talking about buying corporate debt, in part because the legal protection of that principal gives some comfort, and that popularity scares me a little bit; and if you lend money to a company you should make sure to understand that company’s prospects at least as well as you do when you invest in its common stock.

To their credit, they do include a bit of a warning about the complexity of these investments in the ad, though the warning largely serves to make their service seem more important:

“Unless you have decades of investment experience, I strongly advise you NOT to buy “Mega-Bonds” without the guidance of an expert.

“The first thing you need to understand is that the details you’ll need to successfully research individual “Mega-Bonds” are not easily accessible. You won’t find them listed in the pages of The Wall Street Journal.

“Second, each individual “Mega-Bond” has a unique 9-digit code. Without an industry “insider” like Mike Williams, who knows where to find these codes, it’s difficult for the average investor to take advantage.”

You can certainly find those 9-digit codes, the CUSIP numbers, using any of a number of sources, including the FINRA links I included above — but I’d have to agree with the general principle: These are hard investments for some individuals (including me) to understand, and it can be especially tough to build a diversified portfolio of corporate debt of any kind unless you have a large portfolio and the time to pick up a new time-consuming hobby. That’s why, when you hear pundits talk about the appealing nature of high yield debt, corporate debt, or convertible bonds, they will often suggest letting a mutual fund or closed-end fund manager handle the buying for you. That was the argument of Justice Litle last week, in his teaser for one of the Calamos closed end funds, but there are many funds available of both the closed-end and traditional mutual variety that can provide some diversification and professional management, if that’s what you’re looking for (as always, it’s usually wise to look for experienced, successful managers and lower fees).

The True Income service is fairly new, and I haven’t heard much about the experiences of any subscribers — if you’ve subscribed and think it was either worthwhile or worthless (or somewhere in between), please visit our new Reviews section and let us know your thoughts. Or if you’re buying up some nice high yield corporate debt or convertibles right now, by all means, let us know what you like (or don’t like).



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Nick Cellino
Nick Cellino
February 9, 2009 1:22 pm

I’m passing along an analyst report card that Porter Stansberry published to describe the performance of his analysts in 2008 in which he admits that most of his publications produced negative average returns in 2008. Rob Fannon, the writer of Phase 1, was actually given an “F” by Porter. Mike Williams, the creator of True Income, was given a grade of “Incomplete”, although the average bond he recommended during 2008 fell 35%, because holders continue to be paid their coupons and may recoup all of their losses at maturity. Tom Dyson and Steve Sjuggerud were give the grade of “C”. It’s somewhat refreshing to see such candor on the part of a publisher.

Nick Cellino

“Part II: Why Trailing Stop Losses Matter
By Porter Stansberry

As I told you Friday, while I believe it’s important to measure performance (and to demand good performance), I don’t believe any given year’s quantitative result is the only (or even the best) measure of quality.

Most of our publications produced negative average returns in 2008. Does that mean we did a bad job? Does that mean we’re bad analysts and you’re wasting your money reading our newsletters? Some folks undoubtedly think so.

Last year was the worst year for stocks since 1931. It was the third-worst annual performance of all time. Each major subgroup of the S&P 500 was down more than 20%. Stocks on average fell about 40%. The average mutual fund was down 40%. All our publications did much better than this. And as I showed you on Friday, we were among the few analysts anywhere to predict much of the carnage and get many of the big themes right: real estate, the investment banks, Fannie and Freddie, GM, Goldman, etc.

Our highlights weren’t only on the short side, either. Only two Dow Jones Industrial Average components went up in 2008: Wal-Mart and McDonald’s. Only one significant takeover went through last year: Budweiser. All three of these stocks have been long-time “strong buys” at Stansberry. I told my subscribers back in 2006 they could put up to 25% of their portfolio in Budweiser – the largest allocation I’ve ever recommended. I also reminded people to buy BUD when it was trading under $60 in October while the all-cash $70 InBev buyout was pending. Ferris pounded the table on Wal-Mart in late 2007. It was his top pick for 2008 at our Alliance conference. Likewise, McDonald’s was one of Tom Dyson’s first recommendations for The 12% Letter.

I understand you expect our recommendations to go up – whether the market goes up or not. And an analyst isn’t going to get a good grade from me (an “A” or “B”) unless he has a positive track record. But here’s a question to ask yourself: Am I a better investor after reading S&A research? Looking at our work in 2008, I think there’s no question we’ve given you excellent advice. We urged caution and told you where the trouble was coming from. We put you short the stocks that blew up and long the best stocks of 2008. A