Scandals put squeeze on bondholders

One corporate-bond issuer that has been in the news for all the wrong reasons recently is troubled pharmaceutical group Elan.

Elan is due to repay debt worth more than $900 million (€893 million) before the end of this year, a situation that makes analysts more than a little nervous as they hint at a cash crunch within the company. Add to this a $1 billion bond due for redemption at the end of 2003 and things begin to look pretty hairy for the bondholders.

The $1 billion bond in question is of the convertible variety, which means that it can be converted into shares under certain circumstances. To make things more complicated, the bond is a "put", which means that it can, within certain parameters, be redeemed prior to maturity.

Both Moody's and Standard & Poor's now consider Elan's debt to have junk status, thus making it difficult for the company to raise money on the markets and raising the likelihood that investors would try to call back their capital earlier than initially agreed.

In the current circumstances, this could lead to a situation where bondholders could win control of the company, a vista that holds little appeal for the market. This would happen irrespective of the rights of existing shareholders, who rank further down the pecking-order than major creditors.In general, the increasing incidence of corporates using debt to raise money has meant that bondholders are enjoying more prominence in the financial markets. As with all investments, however, the rough must be taken with the smooth, a fact that is only too apparent to the many bondholders who have recently taken hits.

Earlier this month, investors who held billions of dollars of bonds issued by telecom giant, WorldCom, saw the value of their investments fall through the floor amid news of accounting irregularities. Battle-lines were quickly drawn between bondholders and bank lenders over who should have first call on the proceeds of a company restructuring, despite bondholders being far and away the larger group of creditors. WorldCom was one of the biggest corporate borrowers, with bondholders thought to be owed $26 billion by the company.

Another company where bondholders have felt the slings and arrows of investment misfortune is Enron, which had about $13 billion in debt when it fell from grace. It is is also languishing in the "junk bond" corner of the scrapyard.