Why a Company Would Issue Convertible Bonds

by | Sep 17, 2014 | Podcasts, Stock Market Comments

Last week Twitter raised $1.8 billion in a convertible bond issue. Over the last couple of years, many companies have issued convertible bonds as a way of raising capital. Why convertible bonds though? Tom and Brendan discuss during this week’s Mullooly Asset Management podcast.

In order to explain why companies have been utilizing convertible bonds to raise money, we first need to explain what a convertible bond is. Convertible bonds are interesting because they’re a combination of debt and equity. Investors purchase a bond that comes with the opportunity to convert it into the underlying company’s stock at a later date. The date is normally set in advance along with a conversion price. These bonds typically offer a lower yield than other debt securities because of their tie to the underlying stock’s price. This is also what has made covertible bonds popular in the last few years. They’re often purchased by timid investors who would like to participate in the market, but don’t want the risk of owning stock outright. They obtain limited downside (and upside) by owning the convertible bond instead.

So far in 2014, US-listed convertible bond sales have raised $35.1 billion!

Why would a company want to issue convertible bonds?

Two words: interest rates. The biggest reason companies prefer issuing convertible bonds has very much to do with the historically low interest rates we’re currently experiencing. They can achieve their goal, obtaining capital to grow their business, at super low rates. Like mentioned earlier, convertible bonds have lower yields than traditional corporate bonds. So they get to take the currently low interest rates and lower them even more by issuing convertible debt. Another advantage of selling convertible bonds is that the amount issued does not show up on the company’s balance sheet as a debt. Interest payments, unlike dividend payments, are federally tax deductible.

Two recent and notable convertible bond issues have come from Apple and Twitter.

Apple issued $17 billion of convertible bonds in April of 2013. This was enormous! Apple needed money to finance a stock repurchase program and to increase their stock’s dividend. Apple had the funds to do this on their own, but a lot of their money was held outside the US. Rather than repatriate the money (and pay taxes), they decided to take advantage of low interest rates and raise money through convertible debt instead. You can read more about Apple’s convertible bonds here: http://bonds.about.com/od/corporatebonds/a/Apple-Bonds-What-You-Need-To-Know.htm

Twitter issued $1.8 billion last week in its own convertible bond issue. They were also taking advantage of borrowing at low interest rates, but their need is slightly different than Apple’s. Twitter needs more money due to a current lack of profit being generated. This is a problem a lot of start-up type companies are currently experiencing. Fred Wilson wrote about it here: http://avc.com/2014/09/burn-baby-burn/ These companies are burning through venture capital money at extremely high rates. You can also read more about Twitter’s convertible bonds here: http://www.forbes.com/sites/steveschaefer/2014/09/12/twitter-takes-advantage-of-soaring-stock-with-1-3b-convertible-debt-offering/

Hopefully this week’s podcast will leave you with a better understanding of convertible bonds and why a company might use them to raise money. We highly recommend listening to the podcast and, as always, get in touch with us if you have any questions!

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