BUSINESS

BARGAIN TIME IN THE JUNKYARD

JUNK BONDS MAY BE MAKING A COMEBACK— DESPITE THE COLLAPSE OF THE CAMPEAU EMPIRE

BRENDA DALGLISH August 13 1990
BUSINESS

BARGAIN TIME IN THE JUNKYARD

JUNK BONDS MAY BE MAKING A COMEBACK— DESPITE THE COLLAPSE OF THE CAMPEAU EMPIRE

BRENDA DALGLISH August 13 1990

BARGAIN TIME IN THE JUNKYARD

BUSINESS

JUNK BONDS MAY BE MAKING A COMEBACK— DESPITE THE COLLAPSE OF THE CAMPEAU EMPIRE

A year ago, Robert Campeau charmed shareholders at his company’s annual meeting in Toronto with what, at the time, seemed like candor and gracious benevolence. The elegantly tailored real estate developer chided critics who said that the $12 billion he had borrowed to buy two glamorous U.S. retailers was too much. Debt, he said, was more than a financial obligation—it was a tool to leverage growth.

But, he acknowledged, _

“Charting such a course into new and largely untested waters is never easy—and those who watch from the shore are never patient.” In the end, it was the spectators on land who saw what the captain missed. Now, his company is shipwrecked, and the two prized U.S. retailers have sought bankruptcy protection. Last week, at the latest Campeau Corp. annual meeting, he reminded shareholders that his losses were bigger than theirs. Declared Campeau: “Believe me, I know how you feel.”

It was the collapse of Campeau’s financing that led to a crash in the junk-bond market six months ago. Now, another Canadian player, Gordon Investment Corp., has stepped back into the market, a signal

that at the right price even junk is a bargain, and that the junk market may not be as hopeless as some believed. Gordon Investment, a partnership headed by Bay Street’s most aggressive investment dealer, Gordon Capital Inc., and which includes Hong Kong businessman Li Ka-shing and the Canadian Imperial Bank of Commerce among its partners, announced a plan to buy a $3.6-billion junk-bond portfolio from Columbia Savings & Loan Association of Beverly Hills, Calif. The portfolio is considered a high-risk investment, but its future profits could be huge if the bulk of the 200 or so companies with debt in the fund recover in the next few years. Says Gordon director Tom Allen: “We believe that, over five to 10 years, corporate America will rebound.”

The Campeau and Gordon deals were both audacious, but that is their only similarity. While Campeau waged a hard-fought takeover battle in which he bid up the value of the assets he sought to sky-high levels at a time when the economy was booming, Gordon went bottom fishing, buying devalued junk-bond assets when few others were interested. Now, debt-bur-

dened Campeau is struggling to pay the high interest costs of junk bonds, which offer rates about five percentage points higher than conventional financing because they are not well-secured by assets and, therefore, are riskier. Gordon, on the other hand, will be entitled to collect the high interest rates that it believes the bulk of the companies in the portfolio ultimately will be able to pay.

With the purchase, Gordon goes to the forefront of companies that will find profits in dismantling the excesses of the debt-ridden takeover frenzy of the late 1980s. Said Roland Cardy, managing director of private placements for Toronto-Dominion Securities Ltd.: “Maybe we haven’t hit bottom yet, and maybe the turnaround won’t come for another year or two, but Gordon has got a portfolio of some very important companies.”

Junk bonds, or high-yield securities

as their proponents call them, were one of the most controversial financial instruments of the past decade. Their detractors condemned them for adding too much risk to the financial system. Indeed, it was the high-yield portion of Campeau’s massive debt that was the first to crack under the pressure of rising interest rates and an economic slowdown. Campeau himself has blamed the easy availability of junk-bond financing for enticing him into the risky deal. But the supporters of junk bonds disagree. Kevin McKenna, president of one of the few highyield investment funds in Canada, Toronto-based CCFL Mezzanine Partners of Canada Ltd., says that the bonds are the only way some small and mediumsized companies could raise the money needed to grow. Added McKenna: “Just because there’s a lot of alcohol around doesn’t mean we all have to get drunk.”

High interest rates and the downfall

of U.S. junk-bond innovator Michael Milken— who will be sentenced on Oct. 1 after pleading guilty to insider-trading violations—and his company, Drexel Burnham Lambert Inc., the leading junk-bond underwriter, have dried up the established market in the United States. A fledgling market in Canada was beginning to form last year, but interest in it has now almost disappeared. Observers are divided over whether new junk-bond issues will ever reach their old levels of 1987, when issues represented 22 per cent of the $ 174-billion corporate debt market in the United States. But Gordon’s purchase of the $3.6-billion junk fund appears to be a signal that junk still has a life.

Terry Marlow, a partner in Ernst & Young Inc.’s corporate finance department, applauded Gordon’s management as “incredibly astute value investors.” But he does not expect a rush to issue new junk debt. Said Marlow: “We are probably at the end of a decade of high leverage [borrowing]. The 1990s are going to be back to the basics.” As Campeau illustrates, the takeover excesses of the 1980s have created some conglomerate messes which companies like Gordon, with its special expertise in corporate finance, will make money cleaning up. Allen says that the fact Gordon was not a junk-bond underwriter is appreciated in Washington. Declared Allen: “We came to the table without a background in the creation of the

mess which is now being cleaned up.”

If Washington approves, Gordon will buy the portfolio, which was valued at $3.39 billion in March after the junk-bond market had crashed—and which has an original face value of just under $6 billion—for $3.6 billion with just a $360-million initial payment. Although Gordon is paying a little more than expected, Columbia has agreed to finance the remaining amount. Furthermore, under the terms of the purchase, if the value of the portfolio should fall by 10 per cent or more, Gordon can cut its losses and return the portfolio to Columbia, and lose only its initial $360-million investment. On the other hand, if the companies represented in the portfolio, including giants like RJR Nabisco Inc., survive this economic downturn, the profit potential is great. Said one financial executive familiar with the junk-bond market: “You’ve got to believe a bunch of those companies are going to be opportunities for Gordon to make money.”

It will probably take several years before Gordon’s gamble can be judged a success or a failure. But Bay Street is confident that Gordon’s junk portfolio, which ironically contains some of Campeau’s debt, will undoubtedly fare better than Robert Campeau’s foray into highrisk financing.

BRENDA DALGLISH