Companies have issued a record amount of convertible debt since the start of the year, rushing to lock in rock-bottom interest rates in case recent wobbles in stock and bond markets dent investor enthusiasm.
Convertible bonds come with the right to swap the debt for shares in the issuing company at a pre-agreed price, making them a hybrid instrument sensitive to the outlook for both markets.
Airbnb on Tuesday announced a $2bn convertible deal, the biggest of the year so far, on the heels of Twitter, which announced a $1.25bn convertible bond issue on Monday and Spotify, which priced $1.3bn in notes last week. Beyond Meat increased the size of a convertible bond issue on Tuesday from $750m to $1bn.
All four companies will pay no interest at all on the debt, and investors agreed to conversion prices at hefty premiums to current share prices — ranging from 47.5 per cent in the case of Beyond Meat to 70 per cent at Spotify. For companies, a higher premium means less dilution for existing shareholders if the debt converts; for investors, it means the option to convert is more likely to prove worthless.
“We’ve never seen pricing like this ever in the convertible market,” said Michael Voris, head of convertible bond financing at Goldman Sachs.
The low interest rate environment, coupled with high equity valuations and high volatility in markets amounts to a “triumvirate” that leads to “very attractive convertible pricing”, he said.
The favourable conditions have fuelled the busiest start to a year since Refinitiv started tracking global convertible bond proceeds in 1980. In January and February, companies raised just shy of $34bn, 68 per cent more than in the first two months of last year.
In the US, which accounted for most of the deals, issuers were largely split into two categories: high-growth companies, particularly in the tech sector, and companies that have been hard hit by the pandemic, which have been using convertible debt to repair their balance sheets. The latter category included Expedia, the travel agent, which used the proceeds from its $900m offering last month to buy back existing bonds on which it was paying a higher interest rate.
Companies say investor enthusiasm for convertible bonds has allowed them to raise more than they could elsewhere in the credit markets.
BridgeBio, a biotech start-up, raised $750m in convertible debt in January. “If we’d gone to the senior secured market, I think we probably could have found an additional couple-hundred million dollars of debt,” said Brian Stephenson, its chief financial officer. “It’s just a different order of magnitude.”
And zero-coupon debt would be hard to find outside of the convertible debt market.
“If we were to look at a more traditional term loan, like we had with our prior facility, the interest rate associated with that was much higher,” said Kyle Wailes, chief financial officer at SmileDirectClub, a retailer of teeth straighteners, which issued $650m in convertible bonds a month ago.
But the window for the rosy deals may be closing. The US stock market has wiped out almost all its gains for the year and the tech-heavy Nasdaq is down more than 10 per cent from its peak — declines tied to the recent rise in long-term interest rates.
“If equity markets declined significantly, then companies will be a little more careful about their . . . willingness to issue converts,” said Venu Krishna, deputy head of US equity research at Barclays, citing the higher equity dilution implied by lower share prices.
Companies should take a “very, very close look” at the convertible market now, said Voris of Goldman Sachs. “A year from now, coupons could be 1 per cent. Interest rates could be higher.”