Book Review: How to Make Money with Junk Bonds
How to Make Money with Junk Bonds. 2012. Robert Levine.
Authored by an experienced professional (Robert Levine was founding president of Kidder, Peabody High Yield Asset Management and later ran Nomura Corporate Research and Asset Management for two decades), How to Make Money with Junk Bonds is a well-written, clear, and occasionally humorous tutorial on investing in speculative-grade corporate debt. All essential aspects of high-yield debt are covered. Credit analysis, the bread and butter of high-yield investing, is explained at a rudimentary level. Levine shows, inter alia, how to calculate interest coverage and financial leverage ratios, why EBITDA (earnings before interest, taxes, depreciation, and amortization) is an imperfect measure of cash flow, and why one would want to invest in high-yield bonds in the first place. As a basic introduction to the high-yield debt market in fewer than 200 pages, the book can’t be beat.
What the book is not is an academic-type textbook treatment. For example, Levine notes that the modern high-yield market began with Michael Milken in the mid-1970s. Although this assertion is not entirely incorrect, a more in-depth account would have cited the work of such predecessors as Arthur Stone Dewing, dating back to the 1920s. Levine notes that Milken went to prison, which is true. But someone unfamiliar with that particular history might come away from Levine’s account with the impression that Milken went to prison because of the role of junk bonds in hostile corporate takeovers and greenmail during the 1980s, when in reality he pled guilty to securities and tax fraud.
The book stays away from what are arguably less basic but nonetheless relevant concepts — for example, capital structure inertia and why a company issues debt at different levels of seniority. The author points out, correctly, that high-yield companies “paradoxically” have better covenants than investment-grade companies but fails to take the next step of explaining why, which would have been helpful.
Levine discusses two methods for calculating EBITDA, one using operating income and the other net earnings as their starting points. A more systematic treatment would have included the third method, which uses operating cash flow as its starting point. Although that method is not used extensively in practice, its inclusion would have been instructive. Furthermore, the book’s two examples of an EBITDA computation are ill chosen. In the first example, the net income of Owens-Illinois in 2009 was $162 million according to Levine, whereas the company’s SEC filing reported net earnings of $351 million, a substantial difference that is not explained to the reader. In the other example (Solo Cup Company), the two different calculation methods do not result in the same EBITDA amount. Levine attributes the discrepancy to adjustments that are made for noncash items for distressed companies. But that explanation is too inexact. Different ways of computing EBITDA should lead to the same amount, regardless of method. Making adjustments for noncash, nonrecurring items is a second step, and such adjustments occur — for better or worse — for almost all high-yield companies, not just those in distress.
Finally, the book’s simplicity of exposition, although generally a virtue, results in an occasional sweeping statement. For instance, Levine claims that “private equity transactions place too much debt on otherwise good companies.” All too often they do, but not always. There are many leveraged buyout transactions that “work” — that is, where the company does not go bankrupt and earns a positive return for both the equity sponsors and the high-yield bondholders.
How to Make Money with Junk Bonds appears to be targeted, in large part, to individual rather than institutional investors. Junk bonds, their derogatory label notwithstanding, are not inherently unsuitable for retail investors, considering, as Levine does, that many individuals own stocks issued by junk-bond companies and equity ranks below debt in a company’s capital structure. Still, even after reading the book, an otherwise uninitiated but interested individual might be ill equipped to go it alone in this particularly treacherous market segment. Reading how to do credit analysis and actually doing it are two different things — the latter, done properly, is laborious and time consuming and is enhanced by a learning process that involves experience.
To Levine’s credit, he tempers his enthusiasm by pointing out the many ways in which individuals are at a disadvantage relative to institutions when it comes to high-yield investing. And as a means for retail investors to understand the process of how professionals go about investing the capital entrusted to their care — and as an aid in making an informed decision in selecting among those investment managers — Levine’s book is likely to be of great help.
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