Classic Late-cycle Issuance…in Mid-cycle
Markets can often be tricky for investors in May as bond issuers take advantage of a window of opportunity following the Q1 earnings season and ahead of the typical summer lull. This often results in heavy supply in late April and early May, hence the old trader adage of “sell in May and go away”.
Over the past year, borrowers have benefitted from an extremely supportive backdrop which has rapidly shifted the economy out of recession into a full bull-market phase, resulting in strong investor demand driving credit spreads tighter and creating a situation where yield is becoming an ever more scarce commodity. For investors such conditions can prove challenging, as with market access available to an increasingly broad array of issuers, it is generally a time for buyers to be increasingly discerning with their participation in deals if they wish to avoid potential poor performers down the line.
In this regard we were drawn to the huge bond issue by Amazon yesterday, which may have come as a surprise to many given the company recently published solid Q1 numbers with a staggering $67.2bn of trailing 12-month operating cash flow and $4.2bn of Q1 operating free cash flow. Why might a company with so much balance sheet liquidity decide to issue $18.5bn of debt?
Amazon said the deal was for general corporate purposes (opportunistic acquisitions, working capital etc.), repayment of existing debt and repurchase of common stock. Looking at the final pricing this appears to be a highly opportunistic transaction for the issuer at levels rarely available for corporates, even those as prominent as Amazon. The eight-tranche deal ranged from a $1bn two-year bond priced at a remarkable T+10bp, out to a $1.75bn 40-year deal priced at T+95bp. This is not to say anything detrimental of Amazon – it has been incredibly successful and on every credit metric in my view justifies its solid A1/AA- rating. However, I would question any investor claiming to have the foresight to assess a corporate credit 40 years into the future with less than 1% of credit spread margin above the risk-free rate, and I would also question the rationale for investing in a two-year corporate bond when for just 10bp less you could buy the equivalent US Treasury, with all the additional liquidity the latter would typically provide. It is not much of a stretch to imagine that at some point over the next two to 40 years, it might be possible to pick up these bonds at cheaper levels.
We certainly think this is a smart deal and very cheap funding for Amazon, but to us it highlights the momentum with which this credit cycle is moving and the need for investors to be ever more discerning with their asset selection. If I were a large IG-rated company I would probably be looking to replicate this transaction; as an investor it merely raises my guard.
