When there’s uncertainty in the market, convertible bonds can be a go-to source for companies that need to finance. Because investors are skittish, firms offer them some yield, plus some upside conversion potential, in hopes of luring them off the sidelines.
That’s a pretty fair trade, as long as both sides play by the rules. Of late, that hasn’t always been the case.
In theory, a convertible bond provides investors with a stable yield, as well as the opportunity to convert the security into shares of the issuer. To be equitable, a company may slap a 30 per cent conversion premium on the bonds, so that the shares have to rise by that much before it makes economic sense to convert.
Except lately the premiums have jumped, and on top of that, the underlying stock prices have fallen hard, making the bonds barely convertible.
Last month, Arcan Resources sold $85-million worth of convertible debt. At the time of issue, the conversion premium was 53 per cent. The shares have fallen since, and now the premium is 75 per cent. Same goes for Atrium Innovation Inc.'s $75-million issue, that was priced at a 61 per cent premium. That premium is now 92 per cent.
And back in April, just as energy prices started to come off, Anderson Energy Ltd. sold $47-million worth of convertible debt, at a whopping 75 per cent conversion premium. At that price, it’s barely a convertible bond. It’s just a bond. Yet retail investors eat these things up because the bond carried a 7.25 per cent coupon, which pretty much borders on high yield debt, but is marketed as a much safer option. (However, retail investors are being compensated for the risk, and should understand on their own that the company isn't paying 7.25 per cent because it wants to.)
There are exceptions, of course, and converts aren't necessarily a bad product. But on the whole, investors, be cautious.