Anyone know anything about Convertible Debt?

Question

Convertible Debt is a fund rarising option for new business. Looking for people that know about concerns that arise with this type of raising of capitol and things to look out for.

Answer 1

Convertible debt should be thought of a a sale of equity with a guarantee. If the company does well, the bond is converted to equity. If not, the investor gets his money back -- plus interest.

Convertible debt is issued by growth firms. They are growing faster than their sustainable growth rate -- so cannot rely completely on debt. If the debt does not convert, they are in trouble. They won't be able to get new debt -- because they are near their threshhold -- and it will be hard to issue new equity because new equity owners take the downside but have to share the upside with bondholders.

On the other hand, it it converts, they are in reat shape.

Because of this. convertible debt should only be issued by firms that are confident that they will either do well or go bankrupt.

Once the stock price goes up high enough so that the options are in the money, the company would like the bondholders to convert -- so they can stop paying interest. The bondholders, on the other hand, don't want to convert until the last minute -- because they want interest plus stock.

For this reason, convertible bonds are callable. The company can force conversion by calling the bonds. At that point, investors have 30 days to decide if they want their money back or the stock. Since the stock is worth more than the money -- they convert.

Answer 2

Look at the terms closely. I know a specific situation where someone came in and loaned the company money with a convertible feature but the loan was due in one year. Every year that the company dropped, the debt became due and the company repriced the conversion rate. That person now owns over half the company. Obviously convertible debt can carry significant value in embedded options.

With no repricing, convertible debt still is debt with a significant call option embedded--the issuer of the debt can profit from any upward movement while still preserving all of the loaned capital. That's often a good deal for the issuer and, on the flip side, a bad deal for shareholders since they lose that value given to the issuer.

Answer 3

A convertible bond is type of bond that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. A convertible bond will typically have a lower coupon rate for which the holder is compensated for by the value of the holder's ability to convert the bond into shares of stock. In addition, the bond is usually convertible into common stock at a substantial premium to its market value.

Other convertible securities include exchangeable bonds -where the stock underlying the bond is different from that of the issuer, convertible preferred stock (similar valuation-wise to a bond, but lower in seniority in the capital structure), and mandatory convertible securities (short duration securities, generally with high yields, that are mandatorily convertible upon maturity into a variable number of common shares based on the stock price at maturity).

From the issuer's perspective, the key benefit of raising money by selling convertible bonds is a reduced cash interest payment. However, in exchange for the benefit of the reduced interest payment, the value of shareholder's equity is reduced due to the expected dilution should the convertible bondholders convert their bonds into new shares.

From a valuation perspective, a convertible bond consists of two assets: a bond and a warrant. Valuing a convertible requires an assumption of 1) the underlying stock volatility to value the option and 2) the credit spread for the fixed income portion that takes into account the firms credit profile and the ranking of the convertible within the capital structure. Using the market price of the convertible, one can determine the implied volatility (using the assumed spread) or implied spread (using the assumed volatility).

This volatility/credit dichotomy is the standard practice for valuing convertibles. What makes convertibles so interesting is that, except in the case of exchangeables (see above), one cannot entirely separate the volatility from the credit. Higher volatility (a good thing) tends to accompany weaker credit (bad). The true artists of convertibles are the people who know how to play this balancing act.

A simple method for calculating the value of a convertible involves calculating the present value of future interest and principal payments at the cost of debt and adds the present value of the warrant. However, this method ignores certain market realities including stochastic interest rates and credit spreads, and does not take into account popular convertible features such as issuer calls, investor puts, and conversion rate resets. The most popular models to value convertibles with these features are finite difference ones such as binomial and trinomial trees.

Answer 4

Well, structuring convertible debt is all about details. When can the creditor convert and at wnat price? What anti-dilution measures does the creditor require? Does the creditor require voting rights and, if so, on what basis? Does the creditor require representation on the Board? Is the interest rate low enough to make this financing attractive for the company?

Answer 5

One issue is that when the debt is converted to stock you just gave up some ownership in the company unless the stock its being converted to has no voting rights (preferred stock). Stock also dillutes earnings whereas debt is an expense on the income statement. Research it up a little theres plenty on the net.

Answer 6

I thought it was when a balding middle aged man goes out and buys a new car.

Answer 7

whats the question?
Yea... I know a lot about converts.