Mergers, Acquisitions, and Corporate Restructurings

By Patrick A. Gaughan | Go to book overview

8
JUNK BONDS

The junk bond market and the use of junk bonds as a financing tool for mergers and acquisitions and leveraged buyouts (LBOs) was a very important factor in the fourth merger wave. The availability of very large amounts of capital through the junk bond market made possible the participation of many people who would never have considered participating otherwise. The access to such large amounts of capital also made even the largest and most established firms potentially vulnerable to a takeover by much smaller suitors. The collapse of the junk bond market in the late 1980s was one of the main factors responsible for the slowdown in the pace of mergers in the fourth merger wave. Although this market has rebounded in the 1990s, its growth in the 1990s is not associated with hostile takeovers as much as it was in the past. Rather, it has become an integral component of modern corporate finance providing needed financing for less creditworthy companies. Nonetheless, it remains a smaller but still important part of the merger and acquisition business.


HISTORY

Contrary to popular belief, junk bonds are not a recent innovation. Junk bonds, or highyield bonds, as many of their proponents would prefer to call them, have been around for decades. What is new is that takeover specialists helped pioneer their use as a financing tool for mergers and LBOs. One reason many people think junk bonds are an innovation is that they have had many different names in the past. They went by the term low-grade bonds for decades. In the 1930s and 1940s they were called “Fallen Angels.” In the 1960s some of the lower grade debt that was issued to help finance conglomerate acquisitions was referred to as “Chinese Paper.” Financier Meshulam Riklis, Chief Executive Officer (CEO) of Rapid American Corporation, states that the term junk bonds first originated in a conversation he had with Michael Milken, the former head of Drexel Burnham Lambert's junk bond operation. Riklis claims that when Milken surveyed some of the bonds that Riklis had issued, he exclaimed, “Rik, these are junk!”1 In the 1920s and 1930s approximately 17% of all new corporate bond offerings were low-grade/high-yield bonds. A broader range of firms used these securities to finance their growth. The ranks of the high-yield bonds swelled during the 1930s as the Great Depression took its toll on many of America's companies. In 1928 13% of all outstanding corporate bonds were low-grade bonds; in

1. Connie Bruck, The Predators'Ball (New York: Simon & Schuster, 1988), p. 39.

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