Convertible Note Explainer by luxetvox
Oct 24, 2023 13:32:20 GMT
gutset, keepnthefaith2016, and 1 more like this
Post by icemandios on Oct 24, 2023 13:32:20 GMT
Taken from the SB, and too valuable to allow it to vanish:
10/23/23
luxetvox: Yes, the equity component of the convert is, shall we say, way out of the $. OTOH, as a debt instrument, the yield to maturity of the 4.5% due 2/25 at ~$97 is 6.80%. Hardly a bargain for a non-rated security, w/a $ losing business. And the 1yr T-bill=5.40%
luxetvox: So very little incremental return for a bond with quite a bit of risk, vs a risk free instrument of comparable maturity
luxetvox: And also have very little equity value, given the conversion price vs where the stock is today. Suffice it to say that this puzzling situation makes it a perfect bedfellow for nearly everything else we know about our beloved Opko.
luxetvox: To clarify, when I say 17 million of the converts, I'm referring to par value...what some may call notional value. If bonds are issued at par (most are) then if an institution buys '17 million' in the new issue they would pay $17 million for them....
luxetvox: ...Once the issue starts trading in the secondary market, the price will go up or down from par (100c on the $), depending on whether market rates (treasury yields) have gone down or up, respectively, from where they were on the date of issue. If....
luxetvox: ...company A issues 10yr bonds today, at a spread to the 10yr Treasury, say +100 basis points, then when the deal is actually priced, usually about now during the trading day, the coupon is set at +100 bps to the 10yr UST yield at a fixed time. So ...
luxetvox: ..right now, at this very moment, the UST 10yr yields 4.835%, so the coupon on the new company A bond would be 4.835 + 1.00 = 5.835%, priced at par (what we call 100, but really each 'bond' is $1000). Then if rates plummet in the next 3 months, assuming...
luxetvox: .....no change in company A creditworthiness, the bond issued today would have a mkt price, at that future date, at a premium to par...maybe $101, which would really be $1010/bond. The converse would result if the 10 yr treasury is higher in the next 3 mos
luxetvox: ....so maybe then it could be worth $99, or $990/bond, a discount to par. Now, the equity component of a convert can also cause the mkt price to vary wildly. For example, on 12/27/21, Opko had a wild ride, trading between $4.80 and $5.16. On that day..
luxetvox: ...a block of the converts traded at $140.775 = $1407.75/$1000 par value, i.e., a 40% premium to issuance price of par. Which makes intuitive sense. At issuance in 2/19 the stock price fix was $3.52, and the conversion price was a 20% premium, $4.22.....
luxetvox: ....By Dec '21, the stock (after falling soon after convert was issued....thank you arbs) had rallied from mid $3s to low $5s. So the equity component was way in the money, AND the time to maturity had contracted by nearly three years. So...
luxetvox: ....the convert geniuses came up with a value that was a 40% premium to par. Today, nearly 2 yrs later, the stock has collapsed, but the time to maturity has also decreased, by a lot. So, even with a stock price WAY out of the $, the fixed income value...
luxetvox: ...has kicked in. While the premium to par has evaporated, the convert price, at $97.16 = $971.60/$1000, is nonetheless fairly close to par. So, in fixed income lingo, "17 million (roughly) bonds" traded, at $97.16, which means someone paid....
luxetvox: ....around $16,500,000 for $17 million worth (par/notional) value of bonds. Not a small transaction. As to the why's and wherefore's....they completely escape me.
luxetvox: The notes are due in February 2025. The yield to maturity, which is different from a rate of return, and a much more complex calculation (summation of cash flows), is 6.807%. This takes into account the coupon rate, and the discount to par.
luxetvox: And it is highly unlikely that the convertible arbitrageurs want the stock outright. If the stock was in the money and conversion was a viable option for convert holders, they would be hedging, perhaps by shorting calls. Converts are collars for stocks.