Finding Jewels Mixed in the Junk

While many of the major junk bond investors of the 1980s continue to go down in flames, big-money players are beginning to hunt for value in the rubble.

Some portfolio managers say the latest troubles of junk holders such as Columbia Savings and First Executive have only heightened interest on the part of keen-eyed private investors.

Those investors aren’t looking for a fast buck. Instead, many are smart money players who sense that the deals they can strike now for depressed corporate junk bonds might produce annual returns of 30% or more over the next few years.

J. Thomas Madden, senior vice president at Federated Investors in Pittsburgh, which owns about $600 million in junk bonds, confirmed that conversations are ongoing between Federated and investors who may be willing to make some novel purchases of the firm’s junk.

“We’re interested in talking with people who have deep pockets and who are interested in (buying),” he said. “We want to hear the deal.”

Already, investors’ renewed interest in junk has sparked a small rebound in bond prices. First Boston Corp.’s index of high-yield bonds rose 2% in price in March--the first gain after eight months of devastating losses. That’s the equivalent of a bond priced at $750 rising to $765.

But the buying interest, even if it increases, is unlikely to fuel a broad recovery in the $200-billion junk market. The simple reason is that many of the big junk investors of the 1980s--S&Ls;, insurers and mutual funds--still want desperately to sell. Add to that list Uncle Sam’s growing portfolio of junk from dead S&Ls;, and it’s clear this will be a buyer’s market for a long time to come.

And that is precisely what is attracting some smart money players. They see opportunities in two areas: depressed high-yield bonds of companies that are likely to escape financial problems over the long term, and bonds of ailing companies that would be willing to turn the bond ownership into an equity stake. In the latter case, either the investor or its investment banker would help design a turnaround plan for the company.

Such debt-for-equity swaps already are key elements of some huge corporate reorganizations, such as the one proposed for 7-Eleven parent Southland Corp. What investment bankers expect to see over the next six months is a rise in such rescue proposals for smaller junk issuers. In many cases, deals may be negotiated so that a single investor buys a company’s bonds, dealing directly with the money managers that now own the bonds.

Today’s junk hunters know they would be making a long-term investment. And for that commitment, they must see the potential for a dramatic return on their investment, assuming the firm can be restructured and returned to health.

Tom Nugent, manager of Pacific Horizon High Yield Fund in Los Angeles, figures big investors who rescue junk firms expect annual returns of “20% minimum, and more like 30% to 40%.”

Who loses for those investors to make that kind of money? Mostly, the current owners of junk bonds. If they want to sell, bonds for which they paid $1,000 each must be let go for $700 or $500 or less to make it worth the new buyers’ while. That’s capitalism at its best, or worst, depending on which side of the transaction you’re on.

Junk for Smaller Hunters: Rescuing ailing junk bond issuers is, of course, the domain of very big investors. But well-heeled individuals also are rummaging through the junk pile, local traders say. Those investors are interested mostly in harvesting 15%-plus annual interest payments, with capital gains potential as the kicker.

This is still a game only for investors of ample means. But if you have the money and the willingness to accept risk for a potentially large reward, brokers have plenty to sell. Examples:

* Ken Funsten, analyst at Wedbush Morgan Securities in Los Angeles, has been steering some clients to notes issued by Coast Savings & Loan. The notes, which mature Oct. 1, 1994, and pay 16% annual interest, have been priced around $650 (per $1,000 face value) recently. At that price, the annualized yield is about 25%.

Funsten says Coast’s earnings are “more than adequate” to pay the interest on the notes and the S&L; currently meets the government’s capital standards. The risk would come later, if Coast can’t meet rising capital standards and is unable to repay the notes in full in 1994. But Funsten figures that at the current yield, the notes offer greater reward than is warranted by the risk.

* Pacific Horizon’s Nugent recently bought zero-coupon bonds issued by Vons Cos., the L.A.-area supermarket giant. The bonds, which mature in 1999, will begin paying interest later this year at a 12.75% annual rate. Nugent said he paid about $945 per $1,000 face value for the bonds.

The lure of Vons is that the company is the L.A. market leader and is expected to show strong earnings growth in the years ahead.

Unocal’s Run: Does British Petroleum really want L.A.-based oil giant Unocal Corp.--or are some traders trying to sucker gullible investors?

Unocal’s stock ran up to $33.50 on Monday from $29.375 on March 22 as old rumors of a BP takeover bid surfaced again. Trading in the stock mushroomed. Tuesday, the stock fell $1.625 to $32, though trading continued to be very heavy.

Rosario Ilacqua, analyst at Rothschild Inc. in New York, said it’s no secret that BP has expressed interest in owning a West Coast oil franchise. But he doubts BP would make an unfriendly bid in an era of rising U.S. distaste for foreign takeovers.

Meanwhile, Unocal isn’t interested in a friendly deal. “The company is on the record as stating it is not for sale,” said spokesman Mike Thacher.

Oppenheimer & Co. analyst William Hyler helped knock Unocal down Tuesday when he advised selling. But Hyler still calls it an “asset-rich company” with oil and gas properties that give it a per-share value in the mid-$40s. “I just think it’d be more attractive to buy around $27, to put away long-term,” he said.

Unocal continues to have plenty of fans on Wall Street who believe the company is making all the right moves--selling North Sea properties, reducing debt and concentrating on its California franchise. And many think the time will come when Unocal will sell out to someone.

JUNK REBOUND?

After plunging for eight straight months, the average price of bonds in First Boston’s junk bond index rose 2% in March.

UNOCAL’S BIG TURNOVER

Unocal stock jumped 14% between March 22 and Monday, as trading volume soared.