Busted Convertible Bonds Explained

Busted convertible bonds are kinda like regular convertible bonds. But they’re different in one big way – they don’t have a good chance of being “converted” into regular company stock. Let’s break it down.

What are convertible bonds?

A convertible bond is a special type of bond. Companies sell these bonds to raise money. The bond pays interest to the person who buys it. But there’s a twist.

The person who holds the bond can trade it in for a certain number of shares of the company’s stock. This is called “converting” the bond. The bond comes with a special price, called the “conversion price”. This price tells you how much the stock needs to be worth for it to make sense to trade in the bond.

What makes a convertible bond “busted”?

Now, a busted convertible bond is a convertible bond that probably won’t get converted. This happens when the price of the company’s stock is way lower than the conversion price of the bond.

Let’s say the conversion price is $50 per share. But the stock is only trading at $20 per share. It wouldn’t make sense to convert the bond. You’d be paying $50 per share when you could buy the stock for $20 on the stock market!

When this happens, we call the bond “busted”. It’s not likely to be converted into stock anymore.

What happens to a busted convertible bond?

A busted convertible bond pretty much turns back into a regular bond. It’s not really tied to the stock price anymore. Instead, it’s valued based on the interest payments it makes and when the bond will be paid back.

This means a busted convertible bond trades based on its “bond value”. It acts like a fixed income investment until the company pays it back.

Why would a company issue convertible bonds?

Companies like to issue convertible bonds for a few reasons:

1. They can pay lower interest rates. Investors are often okay with lower interest payments. That’s because they have the potential to convert the bond into stock and make more money that way.
2. They delay stock dilution. When a bond converts into stock, it increases the number of shares out there. This can dilute the value of existing shares. But with convertible bonds, this dilution is delayed or might not happen at all if the stock price stays low.
3. They attract different types of investors. Some investors might not want to buy the company’s stock directly. But they’re okay with buying a bond that could turn into stock. Convertible bonds can bring in these types of investors.

Real-world examples

Busted convertible bonds happen quite often, especially when stock markets go through tough times.

For example, during the dot-com crash in the early 2000s, a lot of tech companies had issued convertible bonds. When the tech bubble burst and stock prices crashed, many of these bonds became busted. They were unlikely to be converted because the stock prices were so low.

More recently, during the COVID-19 pandemic in 2020, many companies saw their stock prices drop sharply. This led to a lot of busted convertible bonds. Companies in hard-hit industries like travel and hospitality were especially affected.

What investors need to know

If you’re an investor, you need to be careful with busted convertible bonds. On one hand, they can offer high yields because they pay interest like regular bonds. This can be attractive if you’re looking for income.

However, busted convertible bonds can also be riskier than regular bonds. That’s because companies that issue convertible bonds are often smaller or less financially stable. They may have trouble paying back the bond if their business struggles.

As an investor, you need to do your homework. Look at the company’s financials and prospects. Consider the likelihood of the stock price rising above the conversion price. And as always, make sure any investment fits with your overall financial goals and risk tolerance.