When privately held Ackerley Communications Inc., an acquisition-minded, outdoor advertising company based in Seattle, sold its $20-million bond in the fall of 1980, for instance, the major institutional buyers were looking for long-term coupons of at least 17%. But the highly leveraged company, which, at the time, had sales of about $34 million and actually carried a negative net worth, avoided paying that rate by offering an unusual feature. In a deal designed by Drexel, investors were given a 15-year interest rate of just 13 3/4%. As added incentive, though, they got warrants that could be converted into shares of Ackerley stock -- if and when the company decides to go public. If no initial public offering takes place by 1985 -- and the company says there are no plans for any stock offering -- Ackerley has left itself an out. It will purchase the warrants from investors at their appraised market value. Says Drexel's Weinroth: "The company has preserved the option of keeping its equity private."
For Ackerley, which was in the midst of a string of acquisitions in the airport advertising and broadcasting industries, having access to any type of long-term capital was critical. Banks were pressuring the company to find sources of long-term financing to support the new properties. But a trip to the equity market would have almost surely been a disappointment, concedes president Barry Ackerley, even if the stock market had been roaring. "We're in a specialized business that's very strong in cash flow but weak in earnings." While the institutions that bought the company's bonds were able to understand the ins and outs of how the company operates, he is convinced that "equity investors would have expected us to show increasing profits every quarter. They simply wouldn't have known how to value our assets."
In the past few years, the universe of sophisticated "junk," or high-yield, bond buyers has expanded considerably. The earliest institutional buyers to become active in the market were specialized mutual funds, such as New York's First Investors Fund for Income Inc. and Boston's Fidelity High Income Fund. But they have recently been joined by the pension funds of such large corporations as Xerox, Allied, and Eastern Airlines -- a low-rated credit that sells its own debt in the junk-bond market. Such investors have been impressed by studies that show portfolios of low-rated bonds outperforming long-term U.S. Treasuries by about four full percentage points -- even after defaults -- since the late 1970s. As the market attracts more money and more buyers, at least some of these investors have been willing to purchase the debt of growing, smaller companies in industries as diverse as communications and casino gambling.
"As buyers," notes William Pike, portfolio manager of Fidelity's High Income Fund, "we're not buying one bond, but a whole portfolio." The protection he and others have taken against a bond default, moreover, isn't found in legal restrictions against an issuer, but in the higher yields -- and the knowledge that, in a pinch, they can unload their bonds. The most active secondary market for junk bonds is maintained by Drexel's high-yield bond department in Los Angeles. Before buying an issue, Fidelity's Pike says, he needs to be satisfied that the company -- public or private -- "has an excellent chance of servicing its debt and has a high enough yield to compensate for the chance that something may go wrong. But there are no assurances, so I like to know there are liquid markets."
If investors have been drawn to the junk-bond market for higher returns, so, too, have a widening circle of Wall Street investment bankers. A pioneer underwriter of lower-rated debt, Drexel has, in some years, done as many high-yield debt deals -- 25 last year -- as the rest of Wall Street combined. But others, including Merrill Lynch, Shearson/American Express, and, First Boston, have been gearing up to play more aggressively in this corner of the market. It isn't very hard to see why. Fees on these issues run from 2 1/2% to 4% of the amount being raised -- three to four times what IBM Corp., the bluest blue chip, might pay. "The whole market has become legitimatized by the institutions," says Mark Lightcap, who left E. F. Hutton & Co. last March to establish a high-yield bond department at First Boston. "It's become a place where companies can go for subordinated capital without being forced into selling equity. Once they've sold bonds, they have more short-term borrowing power."
Now that the long-term debt option is available to a broader array of companies, more and more of them are deciding to use it. In 1978, as the market was just being established, 51 issues of low-rated bonds raised a total of $1.4 billion. During the first half of 1983, however, the market provided a vehicle for more than 50 issues to raise some $5 billion, roughly twice the amount sold in all of 1982. While Wall Street investment bankers expect investor tastes to change from time to time -- sometimes preferring fixed rates to equity features, sometimes the reverse -- nobody sees the demand for high-yield issues moderating any time soon. "There's more money coming into this market than ever before," says Drexel's Joseph. "And an in creasing number of underwriters are learning how it works."
