Archive for June 23rd, 2009

Pdvsa bond coming? Last chance for cheap foreign currency!!!

June 23, 2009

If it were not absurd enough that PDVSA was thinking of issuing US$ 2 billion in bonds, today’s rumour du jour was that the bond was coming and it was going to be for US$ 3 billion, just  to make things even more entertaining.

Now, it will be easy to sell US$ 3 billion of this supposed bond to Venezuelans, that’s the simple part, the tough road ahead is for all of these Venezuelans to be able in turn to sell the bond abroad to international investors, if that is what is coming as rumored locally and strongly today.

Let me try to explain the problem. Venezuela has some US$ 24 billion in bonds already trading in the international markets and PDVSA has another US$ 7.5 billion.

Who buys these bonds?

Mostly international funds interested in either making money by collecting the interest payments from the bonds or by speculating that the price of the bond will go up in the near future. These funds are limited in size and number because Venezuela does not have a good credit rating. Venezuela’s rating is currently at BB- while PDVSA’s is at B+. This says if things get tighter PDVSA will have a hard time paying.

In this market, prices are set by supply and demand. If there are lots of sellers, prices go down and viceversa. Additionally, it is not an infinite market, the market is right now somewhere between US$ 50 and US$ 100 million each day.

Currently Venezuelan bonds are yielding around 12-16% depending on when they mature, i.e. when they have to be paid. Let’s take a simple example, the shortest Venezuelan bond, the 2010, has a coupon of 5.375% per year, that is, you get paid twice a year half of that on the amount you hold.

Let’s say you have 100,000 dollars, you get US$ 5,375 per year in two installments on August 7th. and February 7th. and the bond matures (ends or has to be paid by Venezuela) on August 7th. 2010. Currently that bond costs around 93% of its nominal value, which means to buy $100,000 of the bond, you pay 93,000 dollars.

Thus, if you buy it tomorrow, between now and its maturity there are around a year and 40 days of interest. But in addition you will get 100,000 dollars at maturity, for your 93,000 dollars investment. That means you will make around US$ 7,000 for the increase in price and another 5,375 dollars plus 40 additional days which is like another 500 bucks. So, you get a total of roughly 12,875 dollars on your 93,000 investment or around 12.7% annualized.

So, now PDVSA will issue a  two year bond, supposedly a zero coupon, i.e. it pays no interest but just appreciates in value to 100% at maturity. Based on when the Venezuelan bonds are trading today, it should yield 15%. That is, roughly it should sell in an ideal world at 70%, so that it gives you 15% a year, since you will gain 30% in two years.

Thus, the Government will sell you the bond at around 190% at Bs. 2.15 per US$. This means that if you order US$ 100,000 (and are lucky enough to get it), you pay Bs. 419,000  (195% x 2.15) for each US$ 100,000, then if you can turn around and sell it for 70,000 dollars, then each dollar you get cost you (419,000/70,000)=Bs. 5.98 for each dollar you got.

However, this is the real world. If the Government sells US$ 3 billion that corresponds to the volume (additional volume at that!) that is done by the market each 30 days, so it would take at least a month and half in terms of working days to absorb the full amount, if everyone in Venezuela turned around and sold them Thus, there is too much supply and not enough demand. Which means that the equilibrium price will not be 70% but lower, or the yield to maturity will be higher.

But suppose you are a fund that owns the 2014 Venezuela bond which yields 16% and all of a sudden the 2011 “new” PDVSA bond yields 18%, you quickly sell the 2014 and buy the new Pdvsa bond. But if too many people do this, the price of the 2014 Venezuela bond will then also go down in price.

Get the picture? By selling US$ 3 billion of the two year 2011 zero coupon, the bond itself will likely yield more than the typical Venezuelan bond due to the over supply, which will make people sell all the other bonds to buy the new one.

Now, under normal circumstances that would be ok, except that Venezuela’s yield is quite high already!

Now, the interesting part, is that if the PDVSA bond 2011 dropped below 65% of its price, or a yield of 17%, it would be cheaper for you to buy the foreign currency in the swap market on Thursday at Bs. 6.4 per US$,  than pay Bs. 419 thousand for 100,000 dollars of the bond which will sell at 65%.( (Bs 419,000/65,000)=6.44 per US$)

It seems to me to be a little close for comfort. So, my recommendation is that when conditions are announced, you do the math and likely the best option available would be to just go and buy the dollars in the swap market, this may be the last chance to buy foreign currency so cheap at Bs. 6.4 per US$ or lower.

The strange thing is that PDVSA does not need dollars, it needs Bs. which it will get. But why they want to sell a bond in dollars is what I do not quite understand. Why not sell and indexed bond in Bs.? After all, even if the swap market goes down with this new dollar bond, it will be only very temporary and people will forget that it even wnet down, let alone lower prices of products.

As usual, there has to be a trick somewhere. What it is may not be known, if at all, until the bond and its characteristics are announced. Or it may be that the conditions to sell you the bond are such that there is some specific and particular way for someone to make a few million bucks from the bond.

They don’t call it the robolution for nothing!!!