By Lynn Thomasson and Mary Childs
Oct. 19 (Bloomberg) -- The steepest equity market rally since the Great Depression is turning 2009 into the worst year in a decade for convertible bond sales as executives conclude the cost of the securities is too high.
Companies from Johnson Controls Inc. to Teradyne Inc. sold $23.5 billion in securities that can be swapped for common stock, the least since 1999, according to data compiled by Bloomberg. Sales evaporated after 51 percent of the corporations that issued the debt saw shares rise above exchange prices, the most in 11 years of data, diluting earnings for existing investors.
Outstanding convertible securities have returned a record 43 percent so far in 2009, Merrill Lynch & Co. data show, almost twice that of the Standard & Poor’s 500 Index including dividends. Chief executive officers are reluctant to tap the market until they’re convinced the rally that drove the S&P 500 up 61 percent since March is over, bankers and analysts at Jefferies Group Inc. and Bank of America Corp. say.
“If we were looking to raise capital today, we would consider convertible bonds, but more than likely we would go with traditional debt markets,” Frank Voltolina, the treasurer at Milwaukee-based Johnson Controls, wrote in an e-mail. “That was not the case nine months ago, when convertible bonds were the best economic alternative.”
Johnson Controls
The largest maker of car seats raised $402.5 million in March selling 6.5 percent notes that can be swapped for 36 million shares at $11.19 each. At the time the deal was announced, the conversion premium was 25 percent above its price. Since then, the shares more than tripled to $26.45 on Oct. 16 in New York.
Johnson had 594 million shares at the end of 2008, so changing the notes into equity would have diluted earnings by 6.1 percent. The company offered to exchange each of the securities for 89 common shares and $120 on Aug. 20, leaving $2.1 million of the issue outstanding.
Convertible bonds are debt securities with an option to exchange the notes for common shares at a premium to the market price. They pay lower interest than bonds that can’t be exchanged. They’re attractive when companies don’t expect a gain in their equities to trigger a swap, adding to outstanding stock and cutting the stake of existing shareowners.
Offerings of the securities more than tripled to $12.7 billion in the second quarter after the U.S. government and Federal Reserve lent, guaranteed or spent $11.6 trillion to end the worst credit crisis since the 1930s.
Markets Rally
As the S&P 500’s gains accelerated and sales of high-yield bonds began a 76 percent increase from 2008, convertible offerings declined, falling 48 percent in the third quarter. High-yield bonds are rated below BBB- by S&P and less than Baa3 by Moody’s Investors Service.
“It’s difficult to pull the trigger on a convertible when the high-yield market is open and you don’t like your stock price,” said Robert Aberman, co-head of convertible origination at Jefferies in New York. “If you believe the market is going to turn in general or your earnings will rebound and propel your stock price in the short term, then a convertible is going to be reasonably expensive.”
Wyndham Worldwide Corp., the franchiser of Days Inn hotels, offered 3.5 percent securities due in 2012 in May that can be swapped at $12.73, a 20 percent premium to the price of the stock that day. The shares surged 68 percent to $17.86, giving the bond a 49 percent return, data compiled by Bloomberg show.
Call Options
Wyndham’s securities are convertible into cash equivalent to 18.1 million shares. The company purchased call options boosting the conversion price of the notes to $20.16, Wyndham Chief Financial Officer Thomas Conforti said in an interview. That’s 13 percent above the stock’s closing price on Oct. 16.
“You make the best decision you can with the facts and circumstances as you have them at the time,” said Christopher Feeney, the treasurer for Parsippany, New Jersey-based Wyndham. “If we were to access the unsecured bond market today, it would cost less.”
Teradyne, a designer of test equipment for electronics based in North Reading, Massachusetts, offered $190 million in 4.5 percent notes in March that can be exchanged at $5.48 a share, a 25 percent premium on the day of the deal. The company’s convertible bonds have returned 84 percent as the stock surged 120 percent to $9.86.
Teradyne’s notes can be converted into about 34.7 million shares, about 20 percent of the 169.7 million the company had outstanding on Dec. 31, or cash. Teradyne paid $64.6 million for an option that helps offset the cost of issuing shares following an exchange.
Boston Red Sox
“You want to be in a position to be in control of your destiny instead of someone else, so that was the right thing to do at the time,” said Andy Blanchard, Teradyne’s vice president of corporate communications. “If you went out for money today, you’d certainly be able to do it with better terms and conditions. I wish the Red Sox bullpen was stronger, but there’s a lot of things you could hope for, right?”
Stock and credit markets may never have rallied without convertible sales, said Wyndham’s Feeney. Offerings took off in March, when $2.4 billion was sold. That’s the month the S&P 500 began its rally from a 12-year low and the gap between corporate bond yields and Treasury rates began to narrow from the widest gap ever, according to data compiled by Bloomberg.
Extra yield demanded by investors to own corporate bonds instead of Treasuries narrowed 4.59 percentage points this year to 3.45 percentage points on Oct. 9, according to Merrill Lynch’s Corporate & High Yield Master Index.
First Trade
“I don’t think you get the rally in the spread without us having the first trade,” Feeney said. “We made a good decision at the time. You take the facts as you have them at the time, you make the decision and you live with the results.”
Sales of non-convertible debt rose to more than $1 trillion this year as investment-grade yields fell to 4.86 percent on Oct. 10, the lowest in four years, according to Merrill Lynch data. Junk bonds yield 10.1 percent, below the historical average of 11.1 percent from the past 23 years.
As much as $65 billion in convertible offerings were forecast for 2009 at the start of the year, Tatyana Hube, an analyst at Charlotte, North Carolina-based Bank of America, wrote in a September research report. So far, the total is less than half that, according to data compiled by Bloomberg.
Smaller Supply
The shrinking market is adding to the rally, according to Hube. As bonds matured or were traded for equity, the pool of notes decreased this year by $27.8 billion as of Oct. 12, she wrote in a note to clients. That followed a $19.9 billion contraction in 2009.
Before the credit crisis, the worst quarter for convertible securities was the period ending in September 2002, when $2.88 billion were sold. The S&P 500 rallied 36 percent by the end of the following year, beginning a bull market in which the index doubled by October 2007.
“There’s such a big restoration due for equity prices that people are thinking, ‘Why give away any of that?’” said Tom Deas, treasurer of Philadelphia-based soda ash producer FMC Corp. and the executive vice president of the National Association of Corporate Treasurers. “People tend to do converts when the balance is such that you’re not giving away any upside.”
To contact the reporters on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net; Mary Childs in New York at mchilds4@bloomberg.net.
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