For me it is not clear why corporates issue such bonds. Especially since, there was very often convertible bond arbitrage opportunities (not many hedge funds do this now but I still see new issues coming cheap and performing very well in general). If they are so cheap, what’s in it for the issuer ?
Now, we see more and more so called hybrid bonds which start to get standardized as the rating agencies slowly come to a stable methodology. Those are also accounted as 100% equity (at least under ifrs i think)
Is the future of the convertibles bond market threatened ?
My understanding is that convertable bonds tend to be used in venture capital and private equity, as well as in distressed/turnaround situations. They are not terribly desirable for the issuer because they become equity (an expensive source of capital) in good times, but still have interest payments if the equity does not perform, thus, the worst of both worlds.
From the point of view of company management, it is usually used when there are few other financing alteratives available. Basically, the benefit is that the option is worth money so the coupon rate is lower than it would be if it were ordinary debt. In a venture or LBO situation, the capital provider can count on interest payments until such time as the company does better, and then get a windfall through conversion. If the company has nowhere else to go, they’re stuck with the deal.
Relatively cheap interest for the issuer (assuming you have a decent future) and if converted, they screw the existing equity holders and you no longer pay interest. Seems like a decent deal.
Banks want convertible bonds so they share in the ups of a growing organization. Like a bank simply wants 7% interest while a startup is growing exponentially. A start up I was part of had convertible bonds as the condition to get bank financing.
I don’t have experience in this, but my understanding is that in a VC or PE situation, there are ownership percentages attached to convertibles, realized through contractually determined share lots that aren’t publicly traded, but which still exist for legal accounting and control purposes. If and when the company does go public, the contractual shares are presumably translated to actual publicly traded shares as if there had been a stock split.
they are often used in VC and distressed situations but are still pretty prevalent outside of these. look at ishares CWB. there are plenty of household names on the list that are far from being distressed (e.g. Intel, Verisign, Wells Fargo, Gilead). issuing convertible bonds/debs have a minimial short-term effect on the trading price of the common stock relative to a stock issuance. i think this may be the main reason for issuing these instead of equity. convertible bonds/debs come with a lower yield than straight up bonds/debs and are usually not convertible until the underlying sees 20-50% appreaciation (which, in the big picture, doesn’t really hurt current equityholders all that much). convertible bonds/debs often bypass many senior debt convenants as they are often treated as equity and are junior to senior debt. convertible bonds/debs expands the investor base as it brings in a whole new type of investor (i.e. the ‘wuss-equity’ guy who likes income, low vol and upside all at the same time).
i clearly think convertible bonds/debs are the bees knees and see many benefits for the issuing companies as well.
most commonfolk are probably familiar with current bond (craig), brosnan and connery thus why spots 1, 3 and 5 are occupied by these three. moore and TDalt are lesser known and don’t pop out of this picture on purpose. none but extreme bond fans even know who lazenby is. i personally think on her majesty’s secret service is one of the better bond films and that lazenby beats the crap out of moore and craig.
Thanks, I did not know this. So you’re saying that it’s like a sneaky way to issue new equity without raising attention to dilution until it’s too late? Plus they are low-interest until then.
It does seem that they are suitable for companies that are about to experience high growth stages. Lower interest rates allow early compounding that only starts to cost (via equity dilution) after the company has grown substantialy.
From what I have seen, dilution is often pretty low on the concern list of companies that issue convertible bonds (what I have seen is that these companies often stem from the high growth, special situation, or straight up distressed world).
Another advantage of a convertible bond vs straight equity is that you can secure them with assets, while it is complicated to segregate assets between equity holders.
equityholders don’t care about dilution as much as they care about the issue price of new equity. issuing equity at a discounted price tends to drive the trading price down to that level, at least temporarily, as underwriters short above the issue price to give them the ability to stablize the price if it falls below the issue price and as buying dries up above the issue price as brokers in the underwriting syndicate are actively selling the stock at lower prices and are banned from recommending a client buy the stock until the stock is no longer restricted. issuing equity kills a stock’s momentum and makes it “unbuyable” for much of the investing world.
issuing convertible bonds still prevents brokers in the syndicate from recommending buying any of the stock but the convertible bond syndicate often looks very different from the typical equity underwriting syndicate (so demand for the stock is maintained for the most part) during the solicitation period and there are no direct price stabilization activites on the common stock on behalf of the underwriters.
currently, with rates so low, issuing convertible bonds is effectively issuing equity at a premium to market price and with little impact on the trading price of the stock.
