MBA graduate Lani has spent the past 10 years, researching, discussing and writing about major concepts relating to business and leadership.
Stocks are a way for investors to purchase a portion of an organization and share in its future profits. Investors buy corporate-issued bonds to lend money as a loan, earning interest for the life of the loan. Corporations issue bonds as debt securities (loans) to investors to fund significant projects and overhauls such as new business segment development or large-scale acquisitions. Investors accept loan default risks based on credit ratings and the issuing organization's ability to generate enough profits to repay debt obligations.
Collateral is not required when issuing corporate bonds; instead, investors must rely on the debt issuer's credit rating to determine the likelihood of default. Collateral is a form of insurance designed to cover debt in the absence of cash. Without it, risks are higher as investors are left to rely solely on the issuing organization's ability to repay debt with future earnings. Fortunately for investors, interest rates on corporate bonds are higher than other types of debt securities such as treasury bills, notes, and government-issued bonds.
The risks involved in financing corporate bonds are usually reflected in the bond price, influenced by default and term structure as well as illiquidity (Elkamhi, Ericsson & Wang, 2012). Credit, interest, and liquidity are categories of corporate bond risks directly attached to the performance of the issuing organization. Some corporate bonds have provisions, providing limited insurance against common types of corporate bond risk, but in no way provide a fail-safe. Risk is inevitable and unavoidable.
Therefore, understanding risk is pivotal for investors and corporate bond issuers alike. However, between the two, bondholders are most vulnerable to the threats of default. Without collateral, investors are gambling on the issuer’s capacity to turn profits. Amazon can use debt financing as a funding resource because of its proven ability to maintain market share and generate cash.
An organization’s credit rating is a principal measure when speculating the investment value of a corporate bond. Credit ratings issued and affirmed by reputable credit rating agencies (CRAs) are required for corporate borrower eligibility (Duff, & Einig, 2015), and rely heavily on the expected yield performance during the time frame proposed in the bond. Credit quality designations vary with each CRA ranging from high (‘AAA’ to ‘AA’) to medium (‘A’ to ‘BBB’) to low (‘BB’, ‘B’, 'CCC’, ‘CC’ to ‘C’) (Chen, 2017). Amazon’s credit rating during acquisition funding for Whole Foods was increased to -AA, adequate to justify debt financing well into the billions.
Amazon announced it would acquire Whole Foods in June 2017 for $13.7 billion in cash (Cusumano, 2017). Whole Foods is a national grocery chain catering to upper-middle-class health-oriented customers and boasts over 500 stores nationwide. To fund such a large purchase, Amazon proposed to sell an estimated $16 billion in bonds across seven different maturities (Stone, 2017). Traditionally bonds have a specified maturity date at which time the par value of the bond must be paid (Brigham & Ehrhardt, 2017). The maturity dates for Amazon’s collection of bonds ranged between seven and forty years.
The most popular, 10-year notes, are expected to have a coupon rate of around 3.35% (Stone, 2017). The par value for a bond is the stated value at its inception; the coupon rate is the coupon payment (annual or bi-annual) divided by the par value (Brigham & Ehrhardt, 2017). Bank of America, Merrill Lynch and Goldman Sach’s were responsible for facilitating the underwriting for the $13.7 billion bridge loan. Relying heavily on Amazon’s credit ratings and the projected positive effects of combining with Whole Foods; each financial institution pledged $6.85 billion in 7 to 40-year bonds to finance the union (Brown, 2017). Jeff Bezos’ e-commerce goliath has long focused on substantial investments designed strictly to grow business and increase market share, rather than driving profitability (Clark, 2014). Amazon’s credit rating is no stranger to fluctuations. Fortunately for Bezos, market analysts continue to perceive Amazon bond securities as being well within an investment-grade territory (Clark, 2014).
What It All Means
Market analysts believe the merger will translate to immediate positive credit ratings as future expectations continue to increase for both organizations. Partnership with Whole Foods will make Amazon’s entry to grocery delivery smooth, convenient, and accessible for millions of customers via established locations around the world.
Brigham, E.F., & Ehrhardt, M.C. (2017). Financial management: Theory & Practice 15th ed. Mason, OH: Cengage Learning. ISBN: 9781305632295
Read More From Toughnickel
Brown, S. (2017). GlobalCapital. 7/10/2017, p1-1. 1p. , Database: Business Source Complete
Chen, J. (2017). Credit Quality. Retrieved from https://www.investopedia.com/terms/c/creditquality.asp
Clark, E. (2014). Moody's Cuts Outlook After Amazon Debt Offer. WWD: Women's Wear Daily, 01495380, 12/2/2014, Vol. 208, Issue 112
Cusumano, M.A. (2017). DOI: 10.1145/3132722. Amazon and Whole Foods: Follow the strategy (and the money). Checking out the recent Amazon acquisition of Whole Foods. Communications of the ACM, Vol#60, No. 10.
Duff, A., & Einig, S. (2015). Debt Issuer: Credit Rating Agency Relations and the Trinity of Solicitude: An Empirical Study of the Role of Commitment. Journal of Business Ethics, 129(3), 553-569.
Elkamhi, R., Ericsson, J., Wang, H. (2012). Journal of Futures Markets. Nov2012, Vol. 32 Issue 11, p1060-1090. 31p. DOI: 10.1002/fut.20546. , Database: Business Source Complete
Stone, A. (2017). Barrons.com. Amazon is selling bonds to fund whole foods purchase. Retrieved from http://www.barrons.com/articles/amazon-is-selling-bonds-to-fund-whole-foods-purchase-1502814377
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2019 Lani Morris
Lani Morris (author) from Seattle, WA on August 07, 2019:
Thank you for reading my article and becoming a follower. This case study is designed to be a part of an Amazon series. Check out my first article about Amazon's initial public offering:
Larry Slawson from North Carolina on August 07, 2019:
Very informative. Thank you for sharing!