Okay, there’s a joke about The Inquisition in here somewhere. Or maybe something about Cossacks and 17th century Russia. Or maybe a King Henry thing.
But yeah...all different kind of, uh...conversion.
Way more pedantically, a company might be having a hard time selling or issuing its bonds to Wall Street. In order for them to close the deal, with their stock trading today at 25 bucks a share, they might say, "well…these bonds are convertible into 20 shares of our stock." That is, a single thousand dollar unit of that bond would convert into 20 shares, which would then value the shares at 50 bucks, which would be sorta the over/under price at which bond holders would start to seriously look at converting.
Why would a company offer convertible bonds instead of just…ya know…bonds?
Well, if they were stuck paying 6% interest on just bonds, but really wanted to only pay 4%, they might get the interest rate discount by throwing in that equity kicker...in the bonds having the convertibility feature. Yes, they would suffer dilution at 50 bucks a share, but that price is double where the stock is today, so the company is probably thinking that it wouldn’t mind some dilution from these bonds being converted waaay up there.
And remember: the bonds pay the 4% interest along the way...until they are converted. The moment those bonds are converted into equity, the debt on the balance sheet of the company (and its obligation to pay that 4% a year interest) goes away fully.
They print 20 more shares for each bond converted, and yes, those shares may pay a dividend…but as far as the convertible bonds go, they are thereafter converted.
And saved. Hallelujah.
Related or Semi-related Video
Finance: What is Busted Convertible?14 Views
Finance a la shmoop..what is a busted convertible?
well techno growth forever biotechs swore to its customers that upon death they [Mans head enters into a glass jar]
could sever their heads freeze them and in 40 years they would have technology
to have them reborn into a really cool robot body and yeah kim kardashian model
was a huge huge hit we cannot lie.... The company stocks zoomed to a hundred
dollars a share and management needed cash to open offices in China Latin [Cash travels around the world]
America and Africa but they didn't want to suffer dilution by just selling
equity or part ownership in themselves to the street at least not at the
hundred dollar share price they really just wanted to borrow money [Cash and an IOU note appears on a table]
to fund these new offices because well they thought their stock would easily
get to $250 a share in the next few years
tons of people out there who wanted to you know live forever
you know like fame.....nevermind their bankers were nervous about how
investors would react to just a straight bond which carried 8% interest so
instead they kind of compromised by doing a convertible preferred stock [Men give handshake]
offering they sold preferred stock to the street that carried just 3% interest
but those preferred shares were convertible into common stock at a
hundred seventy five bucks a share so the owners of the preferred would keep [Stock value of biotech company rises]
clipping their three percent coupons until one day the stock hit a hundred
seventy five bucks or better well and then they could participate in the
[Man hits a baseball] upside if the stock really was a homerun but sadly as many things do in shmoop
video....Test came back from the early decapitating trials and well they were
oh so not good legions of zombies began to roam the streets and while consumers [Zombies walking along the streets]
just didn't want to go there they'd rather truly rest in peace so the stock
cratered down to $20 a share where it would sit for all eternity in what is
called a busted convertible and took us a while to get there but we got
there the convertible preferred would pay 3% a year in interest as it always [Preferred stock with 3% interest sticker]
had and a convertible stock is so far below the conversion price of $175 well,
investors assume it will never convert the investment case views
the convert solely as a preferred or kind of like a bond offering against
competitive bond interest rates so yeah that's a busted convertible although so
is this they really never should have given robot Kim K a driver's license [Robot Kim Kardashian beside an upside down, crashed car]
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