It was always just a matter of time...

I preface this post by reminding readers that I do not give investment advice on this blog. I may muse about investment decisions I'm making for clients, or for myself, but nothing I say is ever intended to be advice. Ever. Never. I'm serious.

In July, I wrote the following as part of a post about HCA's LBO:

The bottom line is this. If you own a diversified portfolio of stocks, odds are good one or more of them will become an LBO target, and you will enjoy wonderful profits. If you own a diversified portfolio of corporate bonds, one or more of them will become an LBO target, and you will suffer.

I wrote that knowing that at some point, it would hit the portfolios I manage. Today, rumors are swirling about Alltel, which is among my largest bond holdings.

This brings up two worthwhile questions. First, knowing that a portfolio of corporate bonds is likely to include some LBO targets at some point, why not eliminate your corporate bond holdings? Let's say you have a portfolio of investment-grade bonds which yields 100bps more than a similar portfolio of Treasuries. Now let's say that 10% of your positions wind up being LBO targets, and these bonds all lose 5 points. That's about 50bps in losses on a portfolio that started out yielding 100bps more. And I have to say, even if you were trying to buy bonds that were potential LBO targets, if you own 30-50 names, winding up with 10% actually getting bought out would be tough.

The second is, what to do now if you hold Alltel bonds? The 2012 issue, which is well-traded, has moved about 40bps wider over the last 2 months, all on speculation that Alltel could be a private equity target. So there is a fair-sized LBO possibility already priced in. Contrast that with how other telecom names are trading:

BellSouth (A2/A) +86
Duetsche Telecom (A3/A-) +121
AT&T (A2/A) +82
Vodaphone (A3/A-) +101
Verizon (A3/A) +87
Sprint (Baa3/BBB+) +161
Alltel (before today) (A2/A-) +189

So that implies that if the LBO thing doesn't happen, but another telecom thinks Alltel's wireless network is worth buying, there might be 100bps of tightening here. What's the downside? Since the Alltel thing is all rumor and no fact right now, we can't say what kind of balance sheet the privatized Alltel might have. That being said, B1/B rated Ford Motor Credit 7's of 13 are currently about +310 to the 10-year. That seems like a reasonable limit to your downside.

Another possibility is for private equity to buy Alltel only to dress it up for a sale back to another telecom. If that happens, there might be less leverage involved than in other transactions.

All in all, I'm holding my Alltel bonds. Its risky, but I think the risk/reward is worth it.