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Bonds: The Day of the Vulture


Michael Embler is a scavenger. With a war chest of $2.5 billion, he makes money for investors in the Mutual Series Fund group by buying the debt of beleaguered companies at deep discounts. He aims to cash out at a higher price once those companies show signs of recovery. His investments range from nursing homes to utilities. But he has largely steered clear of two deeply troubled industries: telecom and cable.

Until now. In May, Embler started to buy up a bit of the nearly $50 billion in debt issued by cable operator Adelphia Communications Corp. and long-distance carrier WorldCom Inc. (WCOM) Embler is one of a few hardy "vulture fund" managers starting to trawl the telecom waters. The lure? Bond prices that have tumbled to as low as 40 cents on the dollar.

Of course, even at such low prices, the risks of buying are high. Investors got burned last year after grabbing distressed debt of the likes of Winstar (IDT), North Point, and Teligent. Those and other upstart telcos raced to build wireless and broadband networks just as prices plunged and all hope of ever earning a profit disappeared. Far from turning around, many failed to emerge from bankruptcy and were liquidated--all but wiping out the vultures' investments.

So why are some of them nibbling again? In part, because this time more substantial telcos, such as WorldCom and Qwest Communications International Inc. (Q), are in trouble. While these companies have huge debt problems from overly ambitious expansions, they have viable operating businesses that produce real revenues and earnings. That means a well-positioned vulture could profit from a rise in bond prices if the balance sheets are restructured--or in the case of a bankruptcy, by gaining control of assets in a debt-for-equity swap. Says Richard C. Siderman, managing director of Standard & Poor's telecom group: Marquee telecoms "may have too much debt, but they're proven business models, as opposed to the other companies that had a lot of debt and were untested."

So far, the action has mostly been in distressed telecom debt. And the list of targets may soon get longer. Precursor Group, a telecom research outfit, predicts that as many as 24 of the 29 major publicly traded telecom companies may be at risk of bankruptcy, including local and long-distance carrier Broadwing Inc. (BRW) and even AT&T Corp. (T) Vultures are also starting to eye troubled cable companies. In addition to Adelphia, some are picking up the debt of European cable operators like NTL Inc. (NLI) and Telewest Communications PLC. (TWSTY)

As the troubles mount, bond prices are likely to keep dropping as anxious investors flee. On May 22, S&P downgraded Qwest bonds to a junk rating. That will no doubt cause investment-grade funds to dump their Qwest bond holdings, since they will no longer meet the funds' criteria. With Qwest's $26.5 billion debt now trading at 77 cents on the dollar, prices are likely to plummet.

But if prices are likely to keep falling, why buy distressed debt now? Indeed, many vultures are holding back from WorldCom and others' debt for that very reason. There, too, many investment-grade bondholders are trying to sell debt. With WorldCom's $30 billion debt already trading at 47 cents on the dollar and much more of it likely to hit the market, prices certainly haven't bottomed. Still, for vultures more interested in short-term gains, the volatility could provide opportunities to buy on the dips and sell on the upswing.

But the timing is tricky. Says veteran fund manager Martin J. Whitman of the Third Avenue Funds, who just picked up some WorldCom debt:"It's like catching a falling knife." Unlike Embler, he figures the company is going bankrupt and he'll make his money by converting his debt to equity. Either way, making a killing on an industry's hard times is far from a sure thing. By Emily Thornton in New York and Roger O. Crockett in Chicago


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