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With interest rates at rock-bottom levels, investing in bonds seems like a recipe for disaster. Yet if you think only the dumb money is buying bonds, take a closer look. You'll find that many companies are making offers to buy back outstanding bonds.

You buy some, you sell some
You have to look really closely to find out about bond buybacks, though. What most bond investors are focusing on is the huge amount of newly issued bonds from blue-chip corporate issuers.

Over the past several months, highly rated companies have one-upped each other by issuing debt at successively lower interest rates. IBM (NYSE: IBM  ) and Johnson & Johnson (NYSE: JNJ  ) were among the first to secure record low rates, with IBM scoring three-year financing at 1% and J&J selling 10-year notes yielding 2.95%. Just a month and a half later, though, Microsoft (Nasdaq: MSFT  ) issued three-year notes with a 0.875% coupon, and just last week, Wal-Mart (NYSE: WMT  ) got an even better coupon rate of 0.75%.

But some corporate issuers are going the other way, choosing instead to repurchase outstanding debt. One way issuers can accomplish this is through a bond tender offer, where the company typically pays a premium to bondholders in exchange for their permission to retire the bonds early. Given that low interest rates and the popularity of corporate bonds generally have already pushed bond prices to high levels, adding a premium on top of that can get very pricey for companies.

Whether that makes sense depends on the reasoning behind the buybacks. In some cases, it's a justifiable move to take advantage of a unique opportunity.

It's all in the timing
The dilemma that many companies find themselves in is that although interest rates are low right now, there's no guarantee that they're going to stay this low for long. And unless a company happens to have its bonds maturing in the next month or two, it has to be concerned that rates will rise before it has a chance to refinance its debt.

Just as most homeowners have to wait for their old home to sell before they can buy a new one, so too do companies typically have to get rid of their existing debt before they can take on a new debt issue. Even those companies that can find bond buyers without extinguishing their current bonds risk a rating downgrade.

So if a company is buying back bonds only so it can then turn around and issue new bonds at much lower interest rates, then that makes plenty of sense. That's what Rio Tinto (NYSE: RIO  ) announced earlier this month, offering to buy back $2.5 billion in notes that will mature in about three years. Similarly, CBS (NYSE: CBS  ) offered to repay $250 million in bonds due to mature in 2012. According to Bloomberg, companies tendered more than $30 billion in bonds last month.

Buying high
On the other hand, if a company is simply retiring debt, then it could hardly pick a worse time to do so. Delta Air Lines (NYSE: DAL  ) , for instance, made a debt tender offer for $340 million back in late August. It simply cited ongoing efforts to reduce debt generally rather than any attempt to refinance at lower rates.

Of course, paying down debt is always a healthy sign for a company, especially in an industry that's been challenged by balance sheet problems. But doing so when prevailing interest rates are low is the worst time possible, because that's when the amount a company has to pay in order to entice bondholders to give up their bonds is as high as it's going to get.

Stay tuned
All of this assumes that the bond market rally is on its last legs. If rates somehow keep falling from here, then those who buy back their bonds now may look like geniuses, while the companies who issued early will look like they passed up even better bargains later. For the moment, though, it's clear that the majority of companies see the current bond environment as an opportunity to extend their debt financing that they can't afford to pass up.

Forget about bonds. Legendary value investor Bill Miller thinks these stocks will rise 50%.

Fool contributor Dan Caplinger is no buyer of bonds right now. He doesn't own shares of the companies mentioned in this article. Microsoft and Wal-Mart are Motley Fool Inside Value picks. Johnson & Johnson is a Motley Fool Income Investor recommendation. Motley Fool Options has recommended diagonal call positions on Johnson & Johnson and Microsoft. The Fool owns shares of IBM, Johnson & Johnson, Microsoft, and Wal-Mart . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy tells you what we're buying.

Read/Post Comments (3) | Recommend This Article (5)

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  • Report this Comment On October 27, 2010, at 11:37 AM, madmilker wrote:

    Whoopee!!! Companies holding a trillion George Washington's but what people fail to notice...they are three trillion George Washington's in the dang hole.

    Just where are those three trillion George Washington's anyway...

    on Wal*Mart's China web page!

    "Wal-Mart China persists in local procurement which provides more job opportunities, supports local manufacture industry and promotes local economy. So far, 95% of merchandising sold at Wal-Mart China store are local products by which Wal-Mart has established business relations with nearly 20,000 suppliers. At Wal-Mart, we treat suppliers as partners and would like to develop with them. In 2008 Wal-Mart won the Supplier Satisfaction published by Business Information of Shanghai for five consecutive years."

    5% foreign in China...

    That doesn't support American exports and American jobs.

    Remember what Lance Winslow wrote in that article "The Flow of Trade in a Global Economy"....

    "Now let us look at Wal-Mart again; you buy a product there, 6% goes to the employees, 10-18% is profit to the company, 25% goes to other costs and 50% goes to re-stock or the cost of goods sold. Of the 50% about 20-25% goes to China, a guess, but you get the point. Now then, how long will it take at 433 Billion dollars at year for China to have all of our money, leaving no money flow for us to circulate? At a 17 Trillion dollar economy less than 40-years minus the 1/6 they buy from us. Some say that if we keep putting money into our economy, it would take forever, but if we do not then eventually all the money flow will go. If China buys our debt then eventually they own us, no need to worry about a war, they are buying America, due in part to our own mismanaged trade, so whose fault is that? Not necessarily China, as they are doing what's in the best interests, and we should make sure that trade is not only free, but fair too."

    Think for a moment about George Washington....yes the man that is on the US dollar bill....How do you think George feels being sent overseas in return for all that foreign so-call cheap items and being left in a foreign bank because the American worker doesn't make anything for the foreigners to buy. Cheap items didn't make this great union of 50 states the greatest place on the face of this Earth.....the American worker (union and non-union) did.

    You can't have a strong country without having a strong currency and you can't have a strong currency unless you keep it floating around within your 50 states. This is why the store with the star in the name puts 95% China made items in their stores in keep their "yuan" in their country helping the nice people there. And with only 5% left for all the other 182 country's that make stuff including the United States of America....that doesn't produce very many jobs outside of China.

    Being an old person myself and knowing how it was back in the 40's, 50's and 60's in this union of 50 states....I look at George each time I pull him out of my billfold and make a promise to send him out for items made in America so after floating around helping each hand he touches just maybe one day he will shake mine again.

    Fifteen cargo ships pollute as much as 760 million automobiles.

    $9 billion a year in hidden taxes to all American taxpayers to clean fish from ballast tanks of ships...

    think about all those facts the next time you pull that George out of your pocket....

    Retail makes NOTHING...

    Governments only make MORE DEBT...

    It's time for less of those two and for America to get back to what it does best....MAKE STUFF..

    cause George Washington on that dollar can't help anyone in the United States of America if he is being held in a foreign hand.

    Made In America is the only way out of this mess cause foreign made put US here.

  • Report this Comment On October 27, 2010, at 9:25 PM, xetn wrote:


    Your post is complete B.S. For one thing, nobody is being forced to buy stuff at Wal-mart. They are all voluntary exchanges and the consumers who make purchases there, believe they are getting more than what they give up.

    You are right in one sense, we need to start manufacturing again. But the reason we are manufacturing less is due to the high cost of labor and government intervention.

    Another big problem is the Fed's insistence on inflating the money supply to the point that it has lost over 97% of its value since the founding of the Fed. That could be called currency manipulation, the same thing that Timmy G and B. Bernanke keep accusing the Chinese of doing. In point of fact, all the world's central banks are doing the same thing in a race to the bottom.

    As for US manufacturing, here is a snippet from yesterday's Casey's Daily Dispatch:

    The issue I’d like to touch on is the decline of U.S. manufacturing. True, it’s no secret that manufacturing in the U.S. is suffering. But you may find a couple statistics on the rate of decline, particularly over the past decade, truly shocking. Here are some facts:

    In January of 2001, according to the Bureau of Labor Statistics, 17.1 million Americans were employed in manufacturing. Today, a mere 11.7 million Americans work in manufacturing, which reflects a decline of 5.4 million jobs and 32% in just ten years. The last time fewer than 12 million Americans were employed in manufacturing was in 1941.

    The U.S. has lost approximately 42,400 factories since 2001.

    In 1959, manufacturing represented 28% of U.S. economic output. In 2008, it represented 11.5%.

    Mass production and advanced manufacturing techniques were born in the U.S. But thanks to a heavy-handed regulatory establishment that makes manufacturing here cost prohibitive in many cases, even homegrown tech powerhouses like Dell and Apple are opting to manufacture their products elsewhere. Just last year, Dell announced that it would be closing its last large manufacturing facility in the U.S. while greatly expanding operations in China. And according to Apple, “significant portions of the Company’s Mac computers, iPhones, iPods, logic boards and other assembled products are manufactured by outsourcing partners, primarily in various parts of Asia.”

    These days companies prefer to manufacture products anywhere but here, it seems, and the U.S. is now left with a “service” economy (jargon to hide the fact that the country no longer makes anything). What’s more, if the U.S. continues to allow its manufacturing base to erode at such a pace, how long can it be before the whole thing collapses under the weight of the debt accumulated to fuel consumption at the expense of production?

  • Report this Comment On October 30, 2010, at 1:57 AM, ChrisBern wrote:

    People have been making a killing on bonds in Japan for 20 years. The "dumb money" in Japan has been in equities and real estate. I understand the skepticism in bonds, but this economic malaise will reward bondholders nicely until the economy gets back on "normal" footing, which will likely be 3-4 years from now.

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