NEWSWIRE - February 14, 2000
Topic: Investment Banking
Source: "Salomon Has Its Deal and Eats It, Too, Bailing
Out Holders of Comcast Bonds," by Paul M. Sherer, Wall Street
Journal, Friday, February 11, 2000, page C1.
Synopsis of Article:
In October and November of 1999, Salomon Smith Barney
underwrote a bond issue for Comcast Corp. The bonds were far from
typical coupon paying bonds however. These securities, called
Zones, were designed to provide a return that was better than the
return on the common stock of Sprint PCS. Comcast is a major
stockholder in Sprint PCS.
Note: The WSJ article omits a detailed description of the
securities. Here is a brief explanation derived from the
prospectus for the November 15, 1999 issue. The principal of each
Zone is set to 95% of the price of Sprint PCS stock on November
15, 1999 ($81.6325) and pays 2.0% interest annually. This interest
payment is supplemented by a payment equal to any dividend payment
to Sprint stockholders. At maturity in November 2029, the Zone
would pay the greater of $81.6325 or the value of a Sprint share,
adjusted for splits. Essentially, this should provide the holder
of the Zone with a return that at least 2.0% higher than the
return on the Sprint stock. Finally, Zoneholders had the option to
redeem these bonds for cash equal to 95% of the value of a Sprint
PCS share.
By the middle of January 2000, the bonds were performing well,
but not as well as shares of Sprint PCS stock. This encouraged
many Zoneholders to consider their option to redeem the securities
for cash value. If this occurred, Comcast would be obliged to pay
out cash and reenter capital markets to secure replacement
financing. Since the securities were designed as a long-term
financing tool, Salomon chose to purchase a large quantity of the
outstanding zones at market value. This alleviated Comcast’s
risk of a mass redemption. It was also an unusual move for an
underwriter who is expected to guarantee a selling price for the
securities in the primary market only.
Questions:
- Discuss the three primary functions of an investment
banking firm in the issuance of new securities.
- Why is it unusual for an underwriter to repurchase
securities in the open market? Why did Salomon repurchase a
large portion of the Comcast issue when it was under no
obligation to do so?
- Describe the put option feature imbedded in the design
of the Zone. Who holds the option? What is the exercise
price?
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