Steep Climb for Convertibles

Convertible bonds can keep lifting Internet companies only if their businesses don't stumble.

Or consider SportsLine USA (now called SportsLine.com Inc.), one of the early convertible bond issuers. An Internet sports-media content provider based in Fort Lauderdale, the company had ambitious plans. After seeing the positive response to the Amazon issue in February and global media company CNET Networks’s issue as it was being marketed also in February, says CFO Kenneth Sanders, “our board felt it was cheap financing, and believed that our stock would continue to appreciate.”

Right away, Sanders began talking to bankers at Robertson Stephens Inc., who were able to bring an issue by March 19, a $150 million, 5 percent note due in 2006. At the time, the stock was trading at 521/8, and the 25 percent premium put the conversion price at 651/8.

That summer of 1999, however, SportsLine’s share price was hurt by the general malaise of Internet stocks, dropping into the 20s by August, and the convertibles dipped below 60 cents on the dollar. Because SportsLine had plenty of cash–a total of more than $250 million from the convertibles issue and from cash already on the balance sheet–it suddenly faced an opportunity to buy back bonds and book a profit on the transaction. “We called a special board meeting about going into the open market” to buy bonds, recounts Sanders. “Even though it was only a few months, we thought it was a good thing to do for the equity holders.”

First, in August, the company bought $60 million worth of bonds for $36.4 million, or 60 cents on the dollar, in the open market (convertible rules allow the acquisition of up to 40 percent without a tender offer). Then, in October, the company made a formal tender offer to buy bonds at 76 cents on the dollar, and ended up buying $70.3 million worth, spending $53.7 million. The upshot: The company sold bonds for $150 million, kept $20 million worth, and bought the rest back for $90.1 million. Hence, it got to keep $39.9 million–or $36 million after amortized issuance costs, which it booked as an extraordinary gain in income. The company also saved a bundle in interest expense. For the year 1999, SportsLine paid $4.4 million in interest compared with just $118,000 for 1998.

“We got free cost of capital of $36 million,” says Sanders. “A great result from something that wasn’t planned.” Today, the company has more than $140 million in cash. Of course, Sanders concedes, “It’s going to be difficult, if not impossible, to go back to the convertible market anytime soon, given what we did.” Fortunately, SportsLine has had other avenues for fund-raising.

Hoping for the Best

Like Sports-Line, most Internet issuers have seen their stocks–and their convertibles–fall precipitously. As of October 31, the average Internet convertible was off 33.1 percent and the median issue was down 34.3 percent, says Calamos.

Of course, unlike SportsLine, most Internet issuers do not have the wherewithal to buy back their bonds: They need the cash to finance their business plans. They just have to hope that Internet stocks liven up before too long. In the meantime, for companies that are still not making any money, the interest payments add up to big costs. For example, Redback Networks is paying $30 million in interest annually, and E-Trade is paying $39 million.

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