Tech convertible boom was a tax on the gullible

SmileDirectClub

03/06/2022 15:50

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are his own.)
    By Robert Cyran
    NEW YORK, June 3 (Reuters Breakingviews) - Convertible bonds
theoretically marry the most desirable features of debt and
equity. Investors get a fixed regular payment, but with the
chance to make more money if the company’s shares go up. Or at
least, they do unless a roaring equity market clouds their
judgment. That’s the only explanation for the rash of
zero-coupon convertible debt issued by fast-growing firms like
Affirm  AFRM.O , DraftKings  DKNG.O  and MicroStrategy  MSTR.O 
in recent years. 
    Tech firms issued about $100 billion of convertible debt
between 2020 and 2021 according to Refinitiv, about as much as
the preceding six years. Many offered zero interest, because
that helped them save cash that could be invested in the
business. That meant investors were relying on the value of the
option to convert to shares later, which – so long as the stock
kept rising – seemed quite valuable. Issuers could also set a
high premium, the share-price level at which a bond can be
converted to stock.
    Some used the proceeds more widely than others. Crafty
online marketplace Etsy  ETSY.O  used capital for growth and to
buy back stock from insiders relatively cheaply. MicroStrategy,
on the other hand, bought bitcoin https://www.microstrategy.com/en/investor-relations/press/microstrategy-completes-1-05b-offering-of-convertible-senior-notes_02-19-2021
 when the digital collectible’s value was some 80% higher than
today. Some investors were also smarter than others: while some
funds bought, others shorted companies’ shares, using
convertibles as a cheap way to avoid being squeezed if the stock
went up instead of down.
    The 20% fall in the Nasdaq 100 index over the past six
months has eroded the value of many convertibles. Unprofitable
tech stocks are down by about 50% as tracked by a Morgan Stanley
index. In Wall Street lingo, these converts are “broken.” Some
can be valued as straight-up bonds, but that’s harder for
companies with no coupon payments. Vegan burger maker Beyond
Meat  BYND.O  issued convertibles are trading at around 40% of
their face value, for example. 
    Not all will be duds. After the dot-com implosion two
decades ago, Amazon.com  AMZN.O  convertibles were priced 40%
below face value, but they eventually were redeemed for stock.
But it seems unlikely that Beyond Meat, betting site DraftKings,
or online dentist SmileDirectClub  SDC.O  will have the
trajectory of an Amazon. Since all of those convertible issuers
are burning cash, it’s not unreasonable to ask if some of these
firms will be able to pay their bonds back at all.
    Follow @rob_cyran https://twitter.com/rob_cyran on Twitter
         
    CONTEXT NEWS 
    Technology firms issued about $100 billion of convertible
notes in 2020 and 2021 according to Refinitiv data. 
    Nearly $90 billion of zero-coupon convertible bonds were
issued by all companies in the same two years.
    Technology firms have issued under $3 billion of convertible
bonds since the start of this year. Among all firms, only about
$1 billion of zero-coupon notes have been issued over the same
time frame. 
    

 (Editing by John Foley and Amanda Gomez)
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