“‘Penny Bonds’ … More Profitable than Penny Stocks?”

By Travis Johnson, Stock Gumshoe, June 16, 2010

Well, someone on the forum just this morning asked if we could “stick a pin in this balloon” … and I’m happy to oblige. The “Penny Bonds” teaser is in an ad for True Income, a newsletter from Mike Williams over at Stansberry & Associates, and it’s all about how these investments can be “more profitable than penny stocks” while offering returns that are just as high.

So what’s the fuss all about? Penny stocks, as we all know, tend to be awfully risky … do these “penny bonds” offer the same level of pants-wetting excitement? Williams says they’re quite a bit safer:

“But unlike stocks, on average, 98.7% of ‘penny bonds’ have historically paid out as obligated each year,
according to a 7-year study published by The CFA Institute

“‘[These] are the closest things to a perfect investment.’ ~International Business Times”

Williams then goes on to make clear that the payouts from these “penny bonds” are contractually bound, that the company is obligated to pay them, and that the returns are “pre-scheduled.”

And he gives one example in the first few paragraphs of the letter:

“For example, have you ever heard of Evergreen Solar Inc (ESLR)?

“It’s an energy firm based out of Marlboro, Massachusetts. Over the past year the company increased its total revenues by an incredible 40%, earning $78.5 million in the first quarter of 2010.

“Its stock trades on the New York Stock Exchange for about $0.80.

“But despite increasing its revenues, Evergreen’s share price fluctuated up and down a dozen times during this period.

“So to entice new investors in this volatile market, the company is now offering a ‘penny bond’ with a contractually bound 196% total return, set to pay out in full on July 15, 2013… whether the stock goes up, sideways or down a little.”

And though he doesn’t specifically recommend these ESLR “penny bonds,” he does say that:

“Dozens of fast growing businesses from every sector of the market are now issuing “penny bonds,” with contractually bound returns of 30% to 400%.

“I can tell you, in 40 years of investing; I believe ‘penny bonds’ are one of the greatest investments the market has to offer. “

And he talks about one successful “penny bond” that he recommended to his readers, the one offered by struggling retailer Rite Aid last year:

“In Feb. 2009, American drugstore retailer Rite Aid (NYSE: RAD) issued a “penny bond.”

“In the months’ prior, Rite Aid’s stock fluctuated between $2.25 and $0.40 … even though the company had increased its annual revenue by 8% that year.

“Sure, like millions of other investors, you could have bought Rite Aid’s stock and speculated as to whether the share price would go up or down… Remember, too, early 2009 was right around when the market was bottoming out…

“But after carefully studying the market, I decided to recommend the company’s ‘penny bond’ to a small group of my readers.

“By September 2009, it was returning a 280% gain… Despite several ups and downs in the stock price.

“The few folks I shared this information with have since made a killing…”

I can verify that Williams has been teasing Rite Aid bonds for a while now — I wrote about an ad he ran back in 2008, so that was well before the February 2009 date he notes, and at a different price probably (which I assume must have been closer to the lows thanks to the debt panic that prevailed then, though I haven’t checked). Back then he was calling these “secured investment contracts,” not “penny bonds,” but no matter the term you make up they’re still pretty much the same.

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He goes on to tease us some more about what distinguishes these “penny bonds” from the stocks that you and I are more familiar with — he lists several differences:

“Difference #1: 98.5% Success Ratio … based on recent data compiled by Capital IQ, only 43% of all penny stocks had positive returns between Jan. 2004 and December 2008.

“On the flip side, before 1987 and 1988, on average, 98.7% of all “penny bonds” paid out as obligated each year, according to a 7-year study by finance expert and NYU professor Dr. Edward Altman and published by The CFA Institute….

“Difference #2: Know the Exact Payout Date You’re Set to be Paid– in Advance …

“Difference #3: Not Listed on the NYSE … they’re rarely advertised in the press… Or by the companies that issue them.

“In fact, most Americans have no clue they exist… because unlike stocks, information about “penny bonds” is notoriously hard to come by.

“Difference #4: Collect Income Checks every 6 months

“As you know, it’s nearly impossible to collect income from a penny stock.

“As far as I’ve found, tiny companies rarely pay dividends. The truth is, they usually reinvest their profits, rather than distribute it to existing shareholders.

“That’s because issuing new shares of stock dilutes existing share value. And paying stock dividends uses up the money the company needs to grow. Issuing a “penny bond,” however, is a much cheaper way for companies to raise capital.

“So as an added incentive for buying a ‘penny bond,’ company’s typically pay annual income checks of up to $100 per bond, which they CANNOT reduce or cancel as long as they are in business.”

OK, so to take you out of your misery — yes, I can tell you what “penny bonds” are, the examples he gives are almost all convertible notes, corporate bonds that are also convertible into common stock at some pre-set ratio (with varying rules about how or when), and the ones I checked are all either not rated or rated very low by the ratings agencies, so for the most part these are “junk convertibles.”

Doesn’t sound as sexy as penny bonds, but there you have it.

And I’d tend to agree that many of us should be considering corporate debt, though it’s not nearly as cheap as it was a year ago when we were all afraid that half the stock market would go bankrupt. Most investors (myself included) are probably very much underinvested in bonds, and we tend to eschew junk bonds just because the companies are more of a credit risk than are blue chips, even as we take ridiculous chances investing in the equity of similar companies — the junkiest junk bond, after all, carries far more promise than almost any stock, since companies have to pay off bondholders before equity holders. Of course, there’s no guarantee that the companies who borrow money in the form of junk bonds or convertible bonds will continue as going concerns, or be able to raise more money to pay off the bond at expiration if the business isn’t generating enough cash to retire that debt, and in practice bondholders sometimes accept less than face value for their bonds instead of fighting through a bankruptcy reorganization, but still, equity holders receive very little “promise” at all.

True Income probably ended up having a good year last year, I’m guessing, though with low-rated bonds the performance month to month can certainly be more volatile than even stock investing, partly because many of these bonds trade in very low volume and their worth also hinges on the underlying performance of what tend to be somewhat stapped or stretched corporations. If you want to see how his subscribers feel about the letter (and a response from Mike Williams himself), you can check out the reviews page — most of the reviews came in early last year, when corporate debt was terrifying, so the early reviews are consistently worse than the later ones, though I have no idea what his overall track record may be.

But don’t worry, I won’t leave you there — Williams did indeed tease two specific bonds for our consideration. And what is a Gumshoe for if not to identify them for you?

Here’s how he teases the two specific “penny bonds” in the special report for his subscribers:

“… the last ‘penny bond’ I found could have shown you a 280% gain in 8 months. But I’ve recently found two U.S. businesses issuing a “penny bonds” that could return even bigger gains. Here’s a brief summary of each:

“‘Penny bond’ #1: One of these companies is a U.S. energy firm now issuing a ‘penny bond’ with a pre-scheduled 90% total return, whether the stock goes up, stays the same or down a little. However, thanks to several new contracts, I believe this company’s profits could grow 10-fold in the coming few years. If that happens I expect “penny bond” holders will receive a huge “bonus” and make even bigger returns.

“‘Penny bond’ #2: The other company is a uranium processor whose “penny bond” is set to pay a 56% total return. But here’s the thing…. Last quarter this company saw its revenue shoot up more than 25%, and if the trend continues, I believe “penny bond” holders will receive a “bonus” that could result in a total return as high as 194%.

“In my latest report: The Two Best ‘Penny Bonds’ of 2010, I’ll give you all the details on this unique situation…. “

OK, so if you happen to be an intrepid Gumshoe yourself, you might note that the clues are much better for that second one than for the first … so let’s go backwards:

“Penny bond” number two must be a bond issued by USEC, which is indeed a uranium processor. The bond CUSIP (a specific identifier that’s widely used for bonds) is 90333EAC2 and you can probably find the details through the bond info service from whatever broker you use, but the basics from FINRA are available here.

That bond is indeed convertible into 83.654 shares, though I haven’t read the prospectus so I don’t know what the details of the conversion are, and it matures in October, 2014. Converting right now wouldn’t make any sense, since the bond last traded for about $720 (per $1,000 of face value) — that means in order for conversion to make sense from this price the shares have to get up to $8.60, or the bond has to fall to about $434.

But still, it does pay a decent coupon (that’s the interest payment you receive) — the coupon is 3%, but the interest payment is based on the principal amount of $1,000, not the last trade of $720, so the payment is $30/year. That’s income of a bit over 4% on a current investment, so to get the big returns that are teased you have to either see the underlying share price rise substantially over the next four years (the shares are currently trading just over $5), or you have to wait it out until maturity, when you’d presumably get your principal back and therefore be repaid $1,000 for your $720 investment — either of those, the conversion thanks to a rising share price or the return of full principal after you bought the bond at a discount, would be a big “kicker” that could bump your annualized returns well into the double digits for this four-year holding period.

As I said, I didn’t dig deeper into USEC (ticker is USU) or this specific bond, but this must be the one Williams is teasing … so you’ve now got the CUSIP if you’d like to dig into this a bit deeper and see if it appeals to you. One final note: USEC carries a fair amount of debt, about $575 million (about the same as their market cap), but it is ALL in the form of this specific bond, so if you buy these you’re apparently at the top of the creditor food chain in the event that the company gets in trouble — and with a very low junk rating from the credit agencies, the assumption is, for whatever reason, that USEC may very well be in over their head. After reading up on the basics I’d definitely consider this bond before buying USU stock, but I can’t say that I’ve been particularly tempted by either in the past.

So … can I figure out the other one? Let’s see … there are the three at least energy-related stocks he gave as examples in the teaser ad, Gasco Energy, Trico Marine and Energy Conversion Devices, so although both those bonds appear to still be out there and still trading at a big discount to the original principal those probably aren’t the ones he’s teasing (Gasco’s CUSIP is 367220AB6, Trico’s is 896106AW1 and ENER’s is 292659AA7, by the way, if you’re interested in following up on them).

What else do we have in the energy space that’s a convertible junk bond? Well, there are several, and I can’t really narrow down for you exactly which one it might be, but the ones that pop up at the top of my list that are energy related, with convertible bonds that trade at a significant discount and might give a big pop if the stock performs well over the coming few years are Rentech, LDK Solar, and Suntech Power. The latter two are Chinese solar companies that you may well have heard of, Rentech is a “clean” energy and synthetic fuels company.

All three are, broadly considered, plays on increasing focus on alternative energy. Suntech Power (STP) is the granddaddy of Chinese solar companies and LDK Solar (LDK) was an upstart that wanted to recycle polysilicon to cut costs and hit some trouble a couple years ago before recovering, but both are essentially in the same boat now — facing overcapacity in China and the worry that the biggest subsidized markets in Europe have concerns beyond funding solar rooftop arrays right now, and both stocks are down substantially from where they were two years ago. But as I said, they’re both Chinese … so if we’re talking about a U.S. company Rentech is the best match I can come up with for you from these clues.

Rentech (RTK), which I don’t remember every writing about, is far smaller and is really a “penny stock” with a share price right at a buck ($200 million or so market cap plus $100 million in debt, half of which is the convertible bond I found). It seems like the technology they focus on primarily is a synfuel process (some version of the Fischer-Tropsch process, which is used on a grander scale by South Africa’s Sasol (SSL)) that converts various feedstocks (including biomass as well as fossil resources) into synthetic gas, though they also do power generation and run a fertilizer plant. I don’t think Rentek has ever been profitable, and they certainly aren’t now … but they do have some assets that I presume have some value, and they may be in a sweet spot for increasing sales and earnings in the years to come thanks to alternative energy funding or programs of various types.

If you want to look into this particular bond, the CUSIP is 760112AA0 and the FINRA info page is here. The conversion rate is 249 shares per bond, and the $1,000 principal notes are now trading at about $660, so that would mean you’d need the shares to get up to about $2.65 to make conversion worthwhile — and as with the other one I haven’t read the prospectus or looked at the other details of the bond, but presuming that you get repaid the full amount at maturity if the bond doesn’t convert that would be a gain of about 50% from the current discounted price. The coupon is 4%, so that’s a $40 annual yield which would give you a 6% effective income yield while you wait for either principal repayment or a jump in the share price to make conversion worthwhile. Maturity is about three years off, on April 15, 2013.

I’m pretty sure about the USEC bond being a match, but Rentech is more of a guess — if you’ve got any opinion on these bonds, or on convertible bond or junk bond investing in general, feel free to jump in and share with a comment below.

Or, if you’ve ever subscribed to True Income, we’d be delighted to hear what you thought — please click here to submit a review of that newsletter, or here to read the reviews of other Stock Gumshoe readers.



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June 17, 2010 2:51 am

interesting,what is a sweetheart spread technique?

June 20, 2010 2:32 am