Tuesday, February 17, 2009

Don’t suffer the equities markets, buy XFR

The equity and debt markets are topsy turvy from the surprises and pressure from the credit crisis. Investors, scared of their own shadow regarding debt, are pricing all debt at a discount to gain safety in their positions. Yet Big Pharma, an industry with incredible cashflow margins on products and strong barriers to entry into their markets, has also seen it's securities priced at a discount. In the panic of the financial system, there are health care companies with products that customers literally cannot live without. Bristol Myers Squibb, the maker of drugs such as PLAVIX, a blockbuster blood clotting therapy, and Abilify, a blockbuster drug for treating the bipolar, is one such company that investors can buy senior debt offered as a preferred shares of a debt trust (NYSE: XFR).

For those not familiar with debt trusts, these shell companies are created for the benefit of the company and the small investor. The company issues standard debt, receiving favorable rates from the debt markets and tax advantages of issuing debt rather than preferred shares, to the trust. The trust, in turn, sells shares like any other stock sold on the NYSE on the open market. This structure allows small investors to invest with the liquidity of the NYSE market and without the large commissions of purchasing from the major brokers over the counter.

This Bristol Myers Squibb debt trust pays the buyer of the trust shares dividends from the notes held in the trust. The total issue is only 25.5m, and thus not attractive to big fish. Yet safety of the issue has to be considered high considering the size of the total debt, $6.1B compared to BMY's current SEPT 30 08 cash position of over $7B in cash on balance sheet and the 43B market cap. Bristol Myers Squibb, although stagnant in revenue growth of the last few years, has maintained consistent profitability, cost reduction, and a strong cashflow position. Many analysts are positive about the BMY pipeline, but that is not the primary concern for an income investor. Since the objective income investing is to not lose money, instead of looking for growth, buying this trust meets some of the highest criteria of safety.

The optimist amongst us may take a look at the common and wonder why take such a conservative approach to very profitable company. Comparing this security to the common shares which as of 2/13 closed at $21.75 and were yielding 5.7%, one might think the opportunity of principal growth is more attractive than the priority given to debt. That may be the case, but in this day of balance sheet surprises, debt holders do not have arbitrary reductions income at the discretion of management. That being said, any jack-in-the-box event should be covered by the cash on hand. Of the debt currently held, the first $2.5B is not due until Oct 2011. Yet there are plenty of areas that have yielded hidden value for BMY. In the 4Q of 2008, BMY generated $582m by selling it's minority stake in ImClone to Eli Lilly when it took over ImClone. In the first IPO of 2009, BMY IPO'd 20% of Mead Johnson, the baby formula subsidiary and the maker of Enfamil, for $680m. The company retained the other 80% of the company and management indicated it would use the cash from the IPO to pay down debt. Moreover, whenever the debt is retired, the shareholders of this debt trust will receive an immediate 11% return on the par value based on the 2/13 closing price.

Bottom line, the debt markets are the safest place to be in this current environment and Big Pharma may be one of the safest industries because in many cases their main payee is government insurance. There is no need to buy a 3.5% Treasury bond for 30 years or suffer principal losses in equities when solid securities like these offer 6.5%+ yield, the highest capital priority, and a shorter time horizon.

The author is long XFR at $22.35 with a 7% current yield.

XFR Description:

SECURITY DESCRIPTION: Lehman ABS Corp., 6.25% Corporate Backed Trust Certificates, Bristol-Myers Squibb Debenture-Backed Series 2002-18, Class A-1, price to the public $25 per certificate. Underlying securities are the 6.875% Debentures due 8/01/2097 issued by Bristol-Myers Squibb Co. (NYSE: BMY). The certificates pay 6.25% ($1.5625) per annum distributions semiannually on 2/1 & 8/1 to holders of record on the day immediately preceding the payment date. Certificates are callable at the option of the call warrant holder on or after 10/31/2007 at $25 per certificate plus accrued and unpaid interest. Certificate ratings at the IPO were AA by S&P and Aa2 by Moody's. Lehman ABS Corp. is an indirect wholly-owned subsidiary of Lehman Brothers Inc. (NYSE: LEH).


Lockstep said...

Long and strong. The BMY balance sheet has continued to be strong and the capital position has improved in preparation for the patent cliff. In the current deleveraging environment and decreasing yields of risk adverse investments, the yield to maturity of this investment is particularly attractive to hold.


Great recommendation XFR.