debt issuance costs balance sheet

CONVERTIBLE DEBT Why these solutions make sense in 2009?

CONVERTIBLE DEBT: Why these solutions make sense in 2009?
(Abhishek Uppal)

Overview of Convertibles
Convertible debt may be structured as a senior or subordinated debt that is convertible into common stock at a fixed ratio at the option of the holder
A semi-annual tax deductible cash coupon is paid on the security
Flexible call / put provisions to meet specific needs
Maturity is typically 20 – 30 years
Principal amount at maturity (or potentially on a put date), if not converted

Advantages

Lower interest cost than straight debt
If converted, equity sold at a significant premium to today’s stock price
Flexible and customizable structures
Credit ratings are not necessary
No financial covenants
Usually immediately accretive
Broadest market appeal with less market disruption than common stock offering
Quick access to capital and Rule 144A available
Sends strong message to market on upside potential of common stock

Considerations

No equity credit – Debt on balance sheet

Potential dilution if converted; however,

Stock sold at a premium to current market price
Up to par value can be cash-settled upon conversion to mitigate any potential dilution

Potential negative stock price impact during marketing process, however,

Short marketing process mitigates impact
Potentially higher cost of capital than straight debt with strong stock price performance over life of security

Common Drivers for Specific Transactions

Debt Repayment/Cheap Debt Alternative

Low interest expense
Can be structured to mitigate risk of conversion
Convertible Hedge Transactions create lower cost debt alternative
Companies may be able to combine with straight debt swap to reduce bank debt or CP program
M&A Financing Vehicle or Consideration
Dry powder with no negative spread
Fast execution under Rule 144A
Highly structured as consideration/seller paper to target’s owners

Convertibles to Finance Stock Repurchase (CoRALS)

Immediately accretive with low carrying costs
Efficient means to repurchase a large amount of stock outside of Rule 10b-18 limitations

Convertible Restructuring/Repurchases

Push out maturities or put dates – put avoidance strategies
Buy back debt at a discount – meaningful NPV savings
Issue new convertible to refinance existing

Equity Alternative

Issue at a premium/no market discount

144A means no registration
Ability to structure to reduce any potential dilution

Pillars of a Convertible Debt Transaction:

Minimize Cost

Lower Cost of Capital
Convertibles are hybrid securities (either interest-paying bonds or preferred (nonvoting) stock) that can be swapped for common shares. Convertible debt normally comes to market at a lower rate than prevailing interest rates

Less Dilutive
Since convertibles are issued at a premium to current equity, fewer shares must be issued than for an equity offering of the same size (many convertible include further enhancements to minimize potential dilution)

Tax Deductions
Interest expense and issuance costs on convertible debt securities are tax deductible

Maximize Flexibility

Broader Investor Universe
Convertibles are sold to a wide variety of institutional investors in addition to individual equity investors. The equity component offers such investors upside potential, while the coupon / yield offers current yield and downside protection

Impact on Stock Price
Convertibles and common stock sales have comparable impact on stock performance

Quick Access to Market
Rule 144A allows issuers to bypass SEC registration and potential SEC review, expediting time to market

Financial Stability

Strengthen Capital Structure
Once the convertibles are ‘called’ common stock may be used to replace the convert on the balance sheet subsequently de-leveraging and enhancing the long-term capital base

No Covenant Restrictions
Convertible securities can be issued on a senior unsecured, senior subordinated, coverage test nor do they encumber an issuer’s assets. Convertibles are covenant free except for a change of control provision

Less Conservative Call Provisions
Convertibles normally have less restrictive and more relaxed call provisions Typically, convertibles are callable after 5 years

Customization
Convertibles can be customized to meet the specific needs of issuer’s and investors alike by incorporating different structural features including: Hard call protection, “Soft” call protection, Mandatory conversion, Cash or stock redemption, Zero coupon or Cash-to-Zero, High premium

About the Author

Abhishek Uppal college graduate from Cornell University.