Investment grade corporates move into convertible bond market​

By Jake Rickman​

What do you need to know this week?

Investment-grade corporates, which describe the most highly valued publicly traded companies, have increased the value of convertible debt they have raised this year by more than 30%, according to the FT.

Convertible debt describes special kinds of corporate bonds that combine aspects of debt and equity into a single security. Convertible debt begins its life like any other bond: a company like AirBnB or Apple issues IOUs to professional bond investors. In exchange for large sums of cash that investors pay to the company for the bonds, the IOU obligates the issuing company to pay to the holder interest over the course of the bond’s life.

However, rather than maturing and obligating the issuing company to repay the initial loan amount, the convertible bonds may give the bondholders the right or the obligation to convert the outstanding debt to shares in the company. This conversion event extinguishes the existing debt, while the pool of equity dilutes by a corresponding amount.

Why is this important for your interviews?

A common question in the TCLA Commercial Forum is what topics to follow in the commercial world. It’s a great question, and it depends on what interests you. But from a strategic perspective, if you are interested in joining a firm like Clifford Chance, Freshfields, White & Case, or Sidley Austin — all of which have world-leading banking and debt capital markets practices — staying close to the bond market is an excellent choice.

If you can demonstrate to interviewers that you understand the commercial factors influencing the debt capital markets, you will distinguish yourself from other applicants. Using this story, a way in may be to ask, “How is this news significant?”

The answer is that high-value convertible bond issuances have traditionally been the purview of publicly traded companies which the market considers to be high-risk. This is because these companies — e.g. Uber, Ford Motor Credit, Allied Universal — typically struggled to issue competitively priced corporate bonds, likely because they had already raised as much capital as they could from the “junk bond” market. That is, traditional corporate bonds with higher interest rates.

Convertible bonds represented an alternative to raising additional debt capital: rather than issue bonds at high interest rates to compensate bond investors for the perceived risk of lending to a company with a higher credit risk, they could raise debt with a lower cost of capital — i.e. lower interest rates — in exchange for giving investors the future right to own equity in the company.

The downside to convertible debt is that it can devalue the shares of the issuing company. This is because existing equity shareholders price in the fact that their shares will become diluted when the bonds convert from debt to shares.

That so-called “blue chip” companies are prepared to issue convertible debt at the expense of devaluing their shares demonstrates how high interest rates are impacting the finances of even the most creditworthy public companies.

How is this topic relevant to law firms?

No doubt the debt capital market practices in the sorts of law firms mentioned above will welcome this news. An increase in convertible issuances will generate more transaction fees, which have plummeted as interest rate hikes have made issuing traditional bonds more expensive.