Bond rating agencies and debt markets generally agree about the credit quality of companies. When they do not, investors must choose who to believe. It is not a choice that investors confront often, mostly because disagreements usually involve small obscure companies that few people encounter.
But it will not be easy to ignore the developing rift over Elon Musk’s SpaceX. Only a few weeks old as a public company, it has already floated $25 billion in public debt on top of a $2 trillion wager on its stock, so there is a fortune riding on its success.
Ratings companies and the bond market have very different views about how things are going. SpaceX’s bonds have an average rating of BBB across the three majors, Moody’s Ratings, S&P Global Ratings and Fitch Ratings. In the alphabet soup of bond ratings, it is the lowest grade still considered quality before falling into junk territory.
The bond market has other ideas. There, quality is judged by a bond’s credit spread or the additional yield it offers above Treasury bonds of similar maturity. The wider the spread, the lower the quality. Corporate bonds with a BBB rating are trading at an average credit spread of 0.92 percentage points (pp). SpaceX’s bonds, by contrast, trade at a significantly greater average spread of 1.62pp across maturities, higher than BB-rated junk bonds’ average spread of 1.55pp.
While SpaceX has the rating companies’ stamp of quality, the market grades its bonds closer to junk. What this tells you is that despite the frenzy over the company’s initial public offering of stock, with investors placing more than $300 billion of orders for just $75 billion of shares being sold, the biggest, most sophisticated investors in the world see a harder road to success than Musk touts and demand to be compensated accordingly.
It may not seem like a big deal, given that SpaceX’s ratings and credit spreads straddle the line between quality and junk. The difference is that junk bonds are far more likely to default, which is why many institutional investors such as pensions and insurance companies will not buy sizeable junk-rated bonds, if at all.
There are good reasons to think the market is the better arbiter. Markets reflect the collective wisdom of investors rather than the more limited judgement of individuals or groups of analysts. Investors also put money behind their views, so they are highly motivated to get it right, whereas analysts are paid by bond issuers for ratings, resulting in potential conflicts of interest.
That conflict does not usually appear to influence analyst ratings, as evidenced by the frequent alignment between ratings and credit spreads. But the more money and buzz are involved, the greater the opportunity for blind spots to arise.
Case in point, as money poured into popular mortgage-related bonds leading up to the 2008 financial crisis, rating agencies awarded high grades to many of those bonds, including coveted AAA ratings that even the US government no longer enjoys.
As the crisis approached, credit spreads widened, signalling that the risk of default was considerably higher than ratings implied. Credit spreads for AAA rated mortgage bonds were, in some cases, 1pp higher than corporate debt with similar ratings and maturities. The warning proved to be prescient, as we now know.
With SpaceX, the market’s scepticism seems to grow as the outlook extends, with credit spreads substantially higher for the company’s longer-term debt. Its five-year bonds trade at a credit spread of 1.18pp and widen from there, reaching 1.99pp for its 30-year bonds. The average credit rating, meanwhile, is a steady BBB all the way out along the tenor line.
Investing in the broad bond or stock market is the opposite proposition—near-term results are a coin flip, but the probability of success rises over time. One is an investment in the likely continued growth of a wide swathe of America’s private sector. The other is a speculative wager that Musk’s SpaceX will “extend the light of consciousness to the stars” and “build a base on the moon and cities on other planets,” as its registration statement boldly aspires to.
The bond market’s assessment also jibes with SpaceX’s stock. It is a profitless, non-dividend-paying, one-person-controlled, empire-building project trading at more than 100 times sales, about 30 times the valuation of the S&P 500 Index. That is the very definition of a junk stock.
Don’t get me wrong, though. I am rooting for SpaceX. Even if its most fanciful plans never pan out, I hope it makes internet access cheaper and more accessible and puts solar-powered data centres in space. But as an investor, I am also mindful that success is never guaranteed. When I want a progress report, I can think of no more reliable source than the market. ©Bloomberg
The author is a Bloomberg Opinion columnist covering markets.