Corporate Debt Now Being Auctioned Online

May 17, 2002
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MIDLAND — Bear, Stearns & Co. was the first firm to directly auction off corporate debt to investors via the Internet last August.

But Dow Chemical Company issued the first ever industrial corporate bond last summer that was priced directly by investors on the Internet. The company held a two-hour virtual auction just three days after Bear, Sterns did theirs, and raised $300 million for a five-year e-bond package.

For the very first time, investors actually used the Internet to make bids on both the amount and price of the bonds they wanted to buy. Before the August auctions, the Internet had only been used to provide potential buyers with basic information on the corporate securities for sale, or as a means for subscribing to a bond that had already been priced.

“We are pleased with the results. Providing investors with the ability to directly establish the market clearing price is a stair-step improvement in transparency, which benefits both investors and the issuer,” said Dow VP and Treasurer Geoffery Merszei last summer.

The Dow auction system was developed by W.R. Hambrecht & Co., and was set up so every bid could be seen. When investors went online they were greeted with a split-screen. One side showed their accounts, while the other tracked incoming orders from competing bidders without revealing their identity.

“You can watch the deal unfold minute by minute, second by second,” said Mitch Stapley, chief fixed-income officer at Lyon Street Asset Management Co.

Bids were made by 62 potential buyers. Ultimately, 57 investors were awarded amounts up to $40 million in Dow securities when the two-hour auction was over. Normally between 15 to 20 investors are allocated securities in an offering of that size and sales are usually done on the telephone.

“The use of an Internet bond auction allows us to raise funds on a more efficient, less costly basis and provides Dow with access to a broader investor base,” said Merszei.

Dow sold its 7 percent notes at an average price of 99.554, providing buyers with a yield of 7.108 percent or about a point higher than a five-year U.S. Treasury note.

“The technology will change the face of how bonds are distributed,” said Stapley, who has been in the bond business for 20 years.

Stapley said that the bond market trails stocks as far as using technology is concerned, largely because Wall Street brokers tend to lose sales commissions as the method of selling becomes more efficient. Using the Internet to sell bonds, means prices are more uniform and information is easier for investors to get. On the flip side, bond sellers can create some efficiencies for their clients’ offerings.

“For corporate bonds, we’re just really beginning to get into using some of these online trading systems to more effectively manage our portfolios and the investments,” said Stapley.

“You have not exactly had Wall Street firms rushing to embrace this concept of using technology to give investors more accurate pricing on these securities,” he added. “But that’s changing.”

Lyon Street, which manages about $4 billion worth of fixed-income securities, is part of that changing scenario. The firm auctioned off some five-year Dow debt in October, and  Stapley said the online event was transparent.

“Everyone was watching it. Everyone was interacting on it and you don’t normally have that. Before, investors have had to depend on brokers to tell them how the deal was going,” he said. “Whatever we can do to lower our transaction costs will translate directly to the bottom-line performance of our portfolio.”

But Stapley cautioned that using the Internet to auction corporate debt is probably something that only the largest public firms should do. He felt, first, that the company selling the bonds should be well known, and, second, the offering should be worth at least $200 million.

“This isn’t for a small, infrequent issuer that is going to try to bring a $50 million deal to the market. There, you really need to have that brokerage firm placing those bonds,” said Stapley.

Investment counselor Eric Ericksen agreed. He felt that most companies should continue to sell their securities through a broker that has connections to pension plans, mutual funds and other institutional buyers.

“If there is a strong market for bonds, you can sell any. It’s like selling your own house,” he said. “But when there is a weak market for bonds, you really have to have somebody out there pushing it and that’s what the brokerage firms do.

“It may expand to an extent, because for certain issuers it’s a way to go directly out and be more efficient. But I don’t know if it’s going to come to dominate the bond market, even at the institutional level,” Ericksen said of Internet selling. “I just think that the intermediary that the big brokerage firms provide will probably continue to be very important.”

By the way, Bear, Sterns sold $600 million worth of seven-year notes with an interest rate of 7.8 percent from its auction.

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