Bond rating firms and debt markets generally agree about the credit quality of companies. When they don’t, investors must choose who to believe. It’s not a choice that investors confront often, mostly because disagreements usually involve small, obscure companies few people encounter.
But it won’t be easy to ignore the developing rift over Elon Musk’s Space Exploration Technologies Corp., the world’s sixth-largest company by market value and certainly the most scrutinized. 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’s a fortune riding on SpaceX’s 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, according to credit scores compiled by Bloomberg. In the alphabet soup of bond ratings, it’s 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 Treasuries with 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 point. SpaceX’s bonds, by contrast, trade at a significantly greater average spread of 1.62 percentage points across maturities, higher than BB rated junk bonds’ average spread of 1.55 percentage points.
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, insurance companies and some funds won’t buy junk-rated bonds in size 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 judgment of individuals or groups of analysts. Investors also put money behind their views, so they’re highly motivated to get it right, whereas analysts are paid by bond issuers for ratings, resulting in potential conflicts of interest.
That conflict doesn’t appear to influence analyst ratings normally, as evidenced by the frequent alignment between bond 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 in the years leading up to the 2008 financial crisis, ratings companies awarded high grades to many of those bonds, including coveted AAA ratings that even the U.S. government no longer enjoys. As the crisis approached, credit spreads widened, signaling that the risk of default was considerably higher than ratings implied. Credit spreads for AAA rated mortgage bonds were, in some cases, a percentage point higher than corporate debt with similar ratings and maturities. The warning proved to be prescient, as we now know.
With SpaceX, the market’s skepticism 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 1.18 percentage points and widen from there, reaching 1.99 percentage points for its 30-year bonds. The average credit rating, meanwhile, is a steady BBB all the way out.
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 swath of the U.S.’ private sector. The other is a speculative wager that SpaceX will “make life multiplanetary,” “extend the light of consciousness to the stars” and “build a base on the moon and cities on other planets,” as the company’s registration statement boldly aspired.
The bond market’s assessment also jibes with SpaceX’s stock. It’s 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’s the very definition of a junk stock.
Don’t get me wrong, I’m 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 centers in space. But as an investor, I’m also mindful that success is never guaranteed. When I want a progress report, I can think of no more reliable source than the market.
Nir Kaissar is a Bloomberg Opinion columnist covering markets. He is the founder of Unison Advisors, an asset management firm.
This article was provided by Bloomberg News.