Noticed that AON Corporation (NYSE: AON), which is a financially stable and large insurance broker, issued some debt to fund a $1.5 billion dollar takeover of another corporation:
Of these notes, $600 million will mature on September 30, 2015 and bear interest at a fixed annual rate of 3.50 percent; $600 million will mature on September 30, 2020 and bear interest at a fixed annual rate of 5.00 percent; and $300 million will mature on September 30, 2040 and bear interest at a fixed annual rate of 6.25 percent. The offering is expected to close on September 10, 2010.
They have a convenient 5-year, 10-year and 30-year maturity, which compared to the US treasury bond is a spread of 2.05%, 2.35% and 2.52%, respectively compared to the closing quotes in September 8, 2010. AON is receiving very cheap debt financing, and the bonds were rated BBB+, although one can see by a quick look at AON’s financial statements that despite the takeover (which is roughly a $5 billion purchase, half cash, half stock that dilutes shareholders by about 20%) they should still be generating sufficient cash to pay off the debt.
So let’s pretend you are owning some 30-year corporate debt in a less solvent entity (e.g. QWest) and have a yield to maturity of 7.5% on a similar bond. Do you trade 1.25% of yield in exchange for higher credit quality? Or do you think the macro environment (e.g. the risk-free rate) will turn hostile to long bond yields and both assets will depreciate? Very difficult to say.