Phew, just when you think things are slowing down for the summer … out comes a new concept in Gumshoe teaserdom. Porter Stansberry’s folks are launching a new service, called True Income, which invests in something a little bit different … something that they’re teasing as “finally, a safe alternative to stocks!”
The service is just coming out of beta and has been around for a few months, but this is the first time I’ve seen it sold — they say the price is $2,400, but that for you special folks they’re offering it half off, only $1,200.
So what is it?
Here’s the first part of the letter, just to give you a little taste of what they’re selling today:
“What if I told you there’s an investment that could pay you 181% gains over the next 12 months…
“And that this money is SECURED by a legal contract…
“Would you be interested?
‘Well, how about if I told that your 181% gain is required BY LAW to be delivered on this EXACT date: June 15, 2009.
“And that in addition to a 181% gain, you’d also be legally entitled to collect 3 interest payments over that same period, bringing your total return to 227%…
“…Turning every $10,000 invested into $32,700, with almost 100% certainty.Are you getting our free Daily Update
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“Well, before I go any further, I should warn you: After reading this, you may never want to buy stocks, EVER again.
“That’s because this unique opportunity has nothing to do with the stock market… government bonds… mutual funds… or options.
“Instead, it’s something we call a “Secured Investment Contract.”
Good God, I’ve been reading these things for years with a skeptical eye, and I still am almost ready to throw some money at them. That sounds brilliant! 100% certainty? Woohoo!
But there’s a catch … isn’t there?
Let’s look and see.
“Like stocks, “Secured Investment Contracts” are offered by U.S. corporations. It’s a way for them to raise money from the public, and give people a share of their profits.”
And the one they mention in the teaser — the one that’s legally obligated to give you a 181% gain by next year — they disclose as being a “secured investment contract” offered by a company called Vertis, an advertising firm (actually, mostly a company that does advertising inserts and direct mail).
So what is going on here?
As you might imagine, “Secured Investment Contracts” are just corporate bonds. You’ll also see them called debt, or notes, or sometimes convertible bonds, and they have all kinds of complex differentiations among them.
It’s true that a bond is a legal agreement between a company and its lenders (the bondholders) — you give them the money, and in return you hold the bond, and you get the right to receive the coupon interest payments. Those interest payments are set when the bond is first sold (when the money is first borrowed), so you’ll usually see a bond described by the coupon rate and the expiration date, though since they’re traded after being issued the actual current yield on the bond is probably different than the original coupon rate. On the expiration date, the bondholder has the right to have the full principal returned to him (or her), and the term of the bond could be anything — it might be a short-term six-month bond, or a 30 or 40 year bond, or anything inbetween.
Corporate bonds work just like US Treasury bonds, though they are not usually sold at auction to set the initial rate (that’s usually done in conjunction with investment bankers who help to figure out what people will be wiling to pay, and then the bonds are openly traded to set the current price, just like stocks). The major difference between Treasury bonds and corporate bonds, aside from technicalities and specifics that are unique to both, is that the guarantor of Treasury bonds is the US government, whereas the guarantor of corporate bonds is the corporation itself.
So, that’s why people say Treasury bonds are “risk free” — the US Government has a nearly unlimited ability to raise money because they can tax the wealthiest populace in the world to get cash when needed, so people are always willing to lend the US more money. When they get more nervous about the US economy, or they believe that inflation will become a problem, then in theory the interest rate they demand for lending money to the government should go up (and therefore, the value of existing bonds that are traded on the open market should go down), but that’s balanced by the fact that people assume that this is the most rock-solid investment in the world, in terms of a guarantee not to lose your principal, so in practice Treasury bonds often seem stupidly expensive because of that guaranteed safety net. Current treasury bonds at many maturities, for example, yield less than the current inflation rate — so they’re actually losing money, which means a bet on buying those bonds now is a bet that inflation will get better, or it’s just a way to hide in the corner without losing too much money and wait for the storm to blow over (thanks to the coupon payments, a bond at least loses less money to inflation than does that pile of $20 bills stuffed in your mattress).
Corporate bonds, on the other hand, are decidedly not risk free. The example they give in this ad, for Vertis, which is an advertising and direct marketing firm in Maryland (who knows, maybe they package and mail some of the print ad letters that Stansberry uses, too), is an interesting one to look at. That’s because Vertis is in the process of going bankrupt — they’re getting ready to merge with another company, erase the current notes (those are the bonds — all of which mature next summer), and give the note holders new notes or perhaps equity in the new company — they’re not actually recommending that you buy these, so I didn’t read the agreements and the reorganization documents very closely.
This is almost always what happens in a Chapter 11 bankruptcy reorganization for a public company, by the way — the bondholders end up owning the company, for good or ill. That’s how Marty Whitman and so many other prescient investors made a bundle on Kmart, they bought the debt when the company was collapsing, then when the stock value went to zero and the bankruptcy courts helped them reorganize, the bondholders ended up owning the equity in the new Kmart, which then had no debt but a valuable portfolio of retail real estate … and then they merged with Sears, and the magic continued for awhile, until the merry go round stopped a year or two ago and the stockholders again realized that there’s only so much you can do to squeeze out profits if you are unable to run a profitable store that customers like.
But that’s beside the point. The point is, if you hold the bonds of a company you are a lender to that company. If the company is paying you a high interest rate — in this case the coupon rate for the Vertis notes are in the range of 9-14% (though the actual current yield is much higher) — that means the company must, by inference, be a challenging credit risk. And that’s if the notes are trading at par value ($100 or $1,000 or whatever the initial increment of offering for the note was — the principal of the loan, in effect).
In the case of Vertis, I assume the notes were trading at a dramatic discount to the par value, something in the order of 65%, because that’s the only way you can get to the 181% gain teased. If a bond is coming due next year, and the par value of the bond is $100 but the company is in trouble and the bond is only trading at $50, you are technically “guaranteed” that you’ll get $100 for the bond next year and therefore get a 100% return. But if people really believed that the company was able to stand behind the guarantee, of course, it wouldn’t be trading for $50. It’s possible that your advisor thinks he has better information to pick out the gems among the rubble in cases like this, but do note that fixed income investors are not stupid — if there was a good chance the bond would return it’s principal, it would be trading much closer to the principal value.
The ad says,
“If you buy Vertis Inc.’s stock, you have absolutely no idea what’s going to happen to your money over the next 12 months. Maybe it’ll go up. Maybe it’ll go down. It’s impossible for anyone to say with any real accuracy. There are just too many variables. But, on April 16, 2008, Vertis offered a “Secured Investment Contract” with the following scheduled payout:
Payment date: June 15, 2009
Scheduled Return: 227%
Now, that’s not precisely true — if you buy stock in a company that’s about to go bankrupt, in most cases you should know what you’re going to get: Nothing. Sometimes, as for example with the Calpine restructuring a few months back, the common shareholders end up with a small fraction of the pre-bankruptcy share price in new stock, but more often companies that go bankrupt are so hugely indebted that once the bondholders get their share of satisfaction there’s nothing left for common shareholders (and sometimes, not much left for some of the holders of junior debt)
This is a bad example for investing in corporate bonds — it’s a complicated restructuring, with notes swapped out for other notes to extend loans, and with a merger mixed in along with the bankruptcy filing. If you want to try to understand it for yourself, knock yourself out — the SEC filings are here, and the company website is here.
The other example given in the ad that caught my eye is Abitibi Consolidated, which I guess is a subsidiary of the relatively new AbitibiBowater (Which, back when it was plain old Abitibi, was teased by a different Stansberry newsletter, Extreme Value, as a value play based on its timber holdings).
Here’s what they said about this one:
“Since the beginning of the year, Abitibi’s share price has zigzagged between $25 and $9. If you buy the company’s stock today, you might do well. Or the shares could drop in value. Again, it’s simply impossible to predict.
“But on March 13, 2008, the company offered a ‘Secured Investment Contract’ agreeing to pay investors:
“Payment date: April 1, 2008
“Scheduled Return: 57%
“If you took advantage of Abitibi’s offer on March 13th, the company was OBLIGATED to pay you exactly 19 days later, on April 1st. Your exact payment: 57%.”
What they don’t tell you is that Abitibi’s debt was downgraded by Fitch and the other ratings agencyes to CCC and the equivalent — which is really, really low — and that Fitch believed that this 57% payout actually represented a partial default, because the company essentially made a partial cash payment to bondholders and gave them a new bond, with an expiration date further out in the future. The bonds had been trading at a steep discount to their par value, and Abitibi was in no position to pay back the principal in full, so anyone who bought those bonds years ago at the full stated value probably got a bit hosed.
Again, I haven’t dug very deeply into either of these — they are used as examples because they have impressive sounding yields and returns due to specific company restructurings that are complex and potentially dangerous, I don’t know if this is the kind of investment they’re going to seek out for this new True Income service, or if they’ll pick safer bonds and these are just the fiery examples they use to get your attention with returns of 57% or 181%.
I don’t generally invest in individual corporate bonds, and I’m not an expert on this area, so please take my comments with a grain of salt — it’s my honest opinion and assessment, but it might not be entirely correct.
On the other hand, if you’re someone who has any trouble at all reading through an SEC filing like a 10K and understanding it, then you might find a typical bond agreement to be nearly incomprehensible gibberish. And you wouldn’t lend someone money without reading and understanding the agreement, would you?
Perhaps Stansberry and his folks are breaking new ground here — there aren’t many big newsletters for individual investors that focus on bonds, and fewer still that focus on corporate bonds. They’re a little more complicated to buy, and the market is much less transparent (even though it’s huge — it still works mostly through intermediaries, at least for small investors, with challenges to getting a fair price or a “live” price quote). So maybe having a trusted adviser would open this market to more people … and perhaps Porter’s folks will be those trusted advisers for you.
But remember — it may be “secured” and it may come with a “legal agreement,” but if someone has to pay a 15-20% interest rate (or worse, 40% or more) just to borrow money to expand or operate their business, there’s a good reason somewhere in there — they’re maybe having trouble making a profit, they’re in a competitive business that investors don’t like and can’t raise equity capital, they’ve already got buckets and buckets of debt on their books and have trouble paying the coupon … it could be a lot of things, and sometimes when you’re holding a junk bond like these, the company ends up going bankrupt and you have to start caring a lot about whether you own the first lien notes, or the third lien subordinate notes, or what have you … and if it’s really bad, it’s certainly possible (likely, even) that many of the bondholders will get back substantially less than their principal.
So … it’s a complex market, but these high yield corporate bonds do exist, and they are “legally obligated” to repay your principal and make coupon payments through the term of the bond — but “legally obligated” is different than “guaranteed”, thanks to the bankruptcy process, a process that tends not to be a stranger to companies that are borrowing money at 15 or 20%.
Personally, in this arena I’d be much, much more comfortable hiring a mutual fund manager to deal with bonds for me. There are good high yield bond funds and closed end funds that have good performance — Vanguard (just an example, not a recommendation) has a High Yield Bond fund for corporate debt that yields about 8.5% currently, and I would assume they’re awfully conservative — that this is a lot different than taking a flier on a single bond that might double in two years.
As an alternative, there are also a multitude of companies that do this kind of lending and effectively manage portfolios for their shareholders — Business Development Companies like Allied Capital, American Capital Strategies, Apollo, PennantPark, and several others are probably the most well-known … they lend to mid-size companies and often get interest rates of 15% or so for their riskier debt, and in turn borrow money themselves to lever up a bit and pay high dividends to shareholders, so you get exposure to a large crop of somewhat risky debt, which hopefully brings down the risks through diversification. Not quite the same as investing in high yield corporate bonds directly, but certainly easier for many individuals.
Of course, this is not to claim that common stocks are safer than corporate bonds, whether investment grade bonds or high yield junk corporates — if you want to own a company that’s in financial distress, you might well be better off with the debt than with the stock, since the bondholders will end up getting something out of any potential bankruptcy reorganization but the stockholders often get nothing. But then again, if a company is in financial distress, you don’t have to buy either the stock or the debt, you can just look for a better company … and maybe sleep a little better.
The ad goes on to say that there are a few key things to know about these “secured investment contracts” — that they have scheduled payments, year after year, that don’t change; that they don’t plummet like stocks can; that they will pay you even during a corporate crisis; and that they can “safely earn 100% or more.”
All true, I suppose, though you could certainly argue the “safely” part, and argue their promised timeframe of doubling that money maybe in one year, or in 2-4 years. And sometimes they do plummet, if it looks like the company is in big trouble … though if they don’t go into or near bankruptcy or renegotiate those bonds with most owners, they will still be obligated to pay out that principal in the end.
And the “scheduled payments, year over year” is both a good and a bad thing — corporate bonds almost never have adjustable payouts, they have a steady coupon yield over that entire life. This is much different than owning a stock — if you own a dividend-paying stock with a growing business, there’s every chance that in a few years the effective dividend rate you’re getting on the stock (relative to your initial investment) could be higher than you would have gotten from the bond, and the interest they pay you on the bond won’t ever go up with inflation the way many dividends do, over time. Bonds can also show capital gains, if the debt rating improves and later investors are more willing to lend to them at a lower interest rate, then you’ll be able to sell the bond for more than you paid … but generally there’s a ceiling on that, too, since the coupon rate will almost never get lower than safe investments like treasuries.
Finally, they also make this seem a little bit secret by saying that any broker can buy and sell these “contracts” for you, but that you need a hard-to-find 9-digit code. This “secret” 9 digit code is the CUSIP code, which is an identifier for individual bond offerings (and stocks) that are traded over the counter just like a ticker is an identifier for publicly traded stocks on an exchange.
Psst … I’ll let you in on the secret!
You can find the CUSIP code in many ways, it’s not intentionally kept secret — some companies list the codes of their debt on their website, or in their SEC filings, but I think the easiest to use and most useful database of corporate debt offerings is from FINRA — and it’s free, though the quotes are delayed just like free stock quotes.
You can find debt offerings by the company’s ticker quite easily in FINRA’s bond center (as well as government and municipal bond info, though that’s a whole ‘nother beast) … for AbitibiBowater, for example, this is the listing of their various bond offerings — it will tell you the coupon rate, the date of maturity, whether or not it’s callable or convertible (callable means the company can force you to sell it back to them, convertible means it can be converted to common stock at a set ratio or price), and the rating that the debt has been given by the ratings agencies (A is rock solid, B less so, and C is junk, broadly speaking, if you trust Moody’s and Fitch and S&P — but there are a lot of gradations like Aaa or CCC or CCC+ or Caa2, unfortunately no ABBA as far as I know) … and right there are the top of each individual entry you’ll see the CUSIP code, should you wish to tell your broker to try to buy it for you. You’d want to do some other research first, of course, such as figuring out why the company’s debt is trading at a 30% discount to redemption value and lenders are demanding 20% interest coupon payments to hold the bonds (those are just examples) — not too different from researching a company, though it’s foreign for many individual investors.
For this service, Stansberry and Associates has recruited a guy who they say is an expert in corporate bonds, which I don’t doubt (though of course, he has no public track record for you to evaluate), and I guess they’ve done well with the beta service. They will be releasing a monthly newsletter issue with one corporate bond recommendation, along with the CUSIP code and, I assume, the buying instructions about what price you should be willing to pay, and probably some analysis of the company — probably not too different than a standard stock newsletter. They say they’ve got three of these “secured investment contracts” (corporate bonds, if you want to be a square about it) that you can buy right now …
“They include a newspaper company you’ve almost certainly heard of… a popular drugstore chain… and a large construction company.
“If you’re interested, Mike will send you these three 9-digit Codes within the next 30 minutes. All you have to do is follow his step-by-step instructions and relay these Codes to your broker.
“Your scheduled returns should be 117%, 92%, and 69% within the next few years. Not only that, you’ll be set to receive 15 separate interest checks from these companies over the next 2 years, while you wait for your final payout.”
So … I would assume that the drugstore corporate bonds are probably from Rite Aid, since they’re in much more trouble than the other “popular” drugstore chains and some people think they’ll end up going down the drain … and times are tough for a lot of construction companies now if they have any exposure to residential building (as opposed to the infrastructure engineering companies), so it wouldn’t be shocking if they had to pay a lot of interest to borrow money, or if investors demanded a high coupon rate to lend them money … and most newspaper companies are choked with debt and in some danger of having trouble just paying their debt service, so certainly the returns on corporate bonds of many newspaper companies, including the highly leveraged ones, like Tribune Co., will be great if the companies stay afloat and keep paying their coupons.
Remember that some of these companies are also the fallout of the private equity frenzy, they were taken private with enormous amounts of borrowed money, and that debt is still floating around with pretty high coupons for many companies, whether the shares are publicly traded again or not — the bondholders supply the leverage in a leveraged buyout, and if the debt is big enough it can certainly dwarf the company’s assets, especially if the assets and the business are depreciating. Tribune co., for example, last I checked had a market cap of about $2 billion, but an enterprise value (meaning, you add in the net debt because that’s what it would really cost to buy the company) of about $14 billion … so lots of companies have fairly dramatic leverage like this, which is why common stock holders are scared of what would happen to them in bankruptcy proceedings, since it’s not really accurate to say that stockholders “own” the company if the bond holders have that much claim to it … and why lenders are worried about their ability to pay the debt service (the interest rate or bond coupon) on all of that money they borrowed.
So, I won’t try to figure out just from the expected payout rate which of these corporate bonds they might be — there are so many variations that it’s unlikely I’d be right and, as I hope I’ve made clear, I’m far from an expert on corporate debt.
But if you’re interested in this side of investing, where upside is potentially good with distressed companies (but also limited, since bonds don’t often trade at a huge premium to their value at maturity), please take some time to look at the bond agreements, understand the ratings agency ratings, and know that a “secured investment contract” does not mean that you get free money without taking risks. If this advisor turns out to be someone who can take a lot of the risk away while investing in high yield individual corporate bonds, well then more power to him, but you’ll still be better off understanding the process and the investments before you pay anyone to choose them for you.
The only bonds I personally hold individually are Treasury Inflation Protected Bonds (TIPS), and I hold precious few of those just as a small inflation-fighting hedge against a portfolio that is 95% stocks. In general, I’d rather own a company than lend it money. I expect some of you are probably more interested than I in this area — and those who are primarily income focused can often do quite well with a portfolio of corporate bonds (though it might more typically be bonds for rock-solid companies like Johnson & Johnson, 3M or the like than for CCC rated or highly volatile junk debt). Feel free to share.
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