Steep Climb for Convertibles

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

To get the debt off the balance sheet as quickly as possible, some convertible issuers have included clauses that take advantage of Internet stock volatility. Online bank NetBank Inc. and Internet messaging company Mail.com Inc. are among those that have a “make whole” clause in their terms that gives them the flexibility to wipe away the debt if the stock spikes up, while offering some protection to bondholders. The clause allows issuers to call the bonds and convert before the official call date if the stock holds at 140 percent to 150 percent of the conversion price for 20 trading days in a period of 30 consecutive trading days. In that case, the company would compensate bondholders for their loss of interest with payment of the present value of future interest. “It makes the sale a lot easier,” says Lehman’s Suria. So far, however, of those issuers that have included the clause none has been able to use it. And if volatility gives way to a sustained slump, they may never get the opportunity.

Indeed, it’s quite possible these stocks will not recover, making the interest and even principal payments burdensome, if not unbearable. Suria is sticking by the negative reports he issued last June on E-tailers eToys Inc. and EarthWeb Inc., as well as Beyond and Amazon, maintaining that they still have the negative operating cash flows, working capital deficiencies, and steep leverage that concerned him then.

If distressed, they would have a last resort: reduce the conversion price below the market price by just increasing the number of shares into which each $1,000 worth of bonds can convert. However, this strategy sharply dilutes the value of current equity holdings.

Since last March, moreover, the convertible bond market has been effectively closed to many Internet companies. In June, two issues–from Akamai Technologies Inc. and Allied Riser Communications Inc.–came to market. But analysts and investors say these could be aimed only at hedge funds, which can use the convertibles to short the stock. 

Hilary Rosenberg is a freelance writer based in New York.

Bad and Worse

The six best and worst performing convertible bonds this year (to October 31).
Source: Lehman Brothers

Company Coupon Maturity End price of convert. % loss on convert. End price of stock % loss on stock
BEST
NetBank 4.75 6/1/04 $74.50 -5.2% $8.69 -53.0%
America Online 0.00 12/6/19 $50.75 -10.2% $50.43 -33.1%
Critical Path 5.75 4/1/05 $80.13 -19.7% $48.56 -42.9%
E-Trade Group 6.00 2/1/07 $83.88 -20.1% $14.56 -33.8%
Exodus Communications 4.75 7/15/08 $107.63 -22.1% $33.56 -24.4%
Ameritrade 5.75 8/1/04 $65.13 -22.5% $14.63 -32.6%
WORST
USinternetworking 7.00 11/1/04 $38.75 -86.7% $2.31 -95.0%
Rhythms Netconnections 6.75 3/3/12 $15.63 -84.3% $2.19 -93.9%
DoubleClick 4.75 3/15/06 $67.88 -78.1% $16.25 -87.2%
Ventro 6.00 4/1/07 $21.50 -71.7% $4.81  -91.5%
Mail.com 5.25 2/1/05 $30.25 -69.8% $3.25 -79.8%
Internet Capital Group 5.50 12/21/04 $48.25 -66.9% $13.25  -92.2%

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