Steep Climb for Convertibles

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

Up the River

Can Amazon afford the interest payments on its convertible bonds? Not unless its cash flow or stock price improves, or it finds alternative financing.

The company issued one bond in January 1999 for $1.25 billion at 4.75 percent and another last February for 690 million euros at 6.75 percent. For the first issue, the conversion price was set at $78 when the stock was trading at around $60. By the time of the second issue, Amazon’s stock was trading at around $76. The euro bonds have a higher conversion premium–about 36 percent, which puts the conversion price at 104.9 euros (about $102 at the time). This includes a higher rate and a reset feature. On the first two anniversaries of the pricing date, if the stock is below the issue price, the company must reset the conversion price down–to a minimum of 84.9 euros ($72.40 as of October 30)–keeping the conversion within reach for investors.

“Amazon said, pay us a high premium and, in return, if the stock doesn’t do well, we’ll reset the price,” says one investor who asked not to be identified.

But even if Amazon resets the price, conversion is so far away at the stock’s current price of $33 that it could face interest payments for much longer than it originally anticipated. So if the company’s prospects don’t improve soon, which requires a very merry Christmas season, Amazon may have to seek alternative financing from private investors, or face a default on the bonds. At that point, its only choice would be to take drastic measures and increase the number of shares available for conversion. That would wipe out the debt, staving off bankruptcy, but hugely dilute shareholder value. –H.R.

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