When issuing convertibles, investment bankers can offer excellent advice on structuring your offering. However, by serving both institutional investor clients and corporate issuers, the issuer’s interests are not always aligned with those of the underwriters. Panthera Advisers offers non-conflicted, unbiased advice to enable management to optimize deal terms in their shareholders’ interests. 

Typically, new issues are brought at a discount to secondary trading values to ensure a successful transaction. However, managing terms to balance execution risk against long-term cost of capital considerations is imperative to the success of the equity.

 

The Problem With Not Receiving Independent Advice

There are several areas in which independence is imperative in a convert offering:

  • Capital structure optimization – To maximize shareholder value, corporate finance indicates minimizing capital charges. Adding equity-linked securities to the capital structure may be more expensive than is necessary. Other forms of debt may be possible and should be explored prior to a convertible. But if the underwriter does not have the balance sheet to provide this financing, they may steer the client towards their strengths and away from what is optimal.
  • Terms – To enable a successful offering, convertibles are typcially priced at a discount (“cheap”) to where they would trade in the secondary market. But as the beneficiary of this cheapness is the investor, the issuer (or its shareholders) lose this value. It is important to make the offering attractive but when an underwriter has clients on the investment side, they are often balancing the interests of the two parties and may not optimally price the transaction for the benefit of the issuer. Balance is important but we often see new issues priced at too steep of a discount (relative to what is necessary to clear the market) and the issuer’s equity holder’s suffer the price.
  • Structuring – Convert arb. funds are valuable consituents in forming a new issue order book but often underwriter’s treat convert offerings as “one-size-fits-all,” which results in significant value loss to the equity. The convertible offering typically leads to selling pressure from convert arb. accounts. This shaves significant value off of the transaction by lowering the ultimate conversion price. Depending on structure, certain issuers do not require significant arb. orders to execute the transaction. Furthermore, when a call spread is also being purchased, the net hedging should significantly be reduced. However, with arb. accounts driving significantly more trading commissions to the underwriter’s trading desks than outright accounts, there is an inherent conflict that can emerge if their allocations are not monitored. More importantly, their allocations need to be communicated up front, to reduce selling pressure on the day of pricing. 


The Panthera Solution

To evaluate the optimal cost of capital, Panthera begins our engagement by identifying the cost of capital at various prices from the convertible. We then map that to the trajectory of the underlying business and implied stock price at various multiples. We then recommend the appropriate deal structure, including evaluating the optimal timing of a transaction and the form of a transaction, including the high yield option.

To issue high yield debt, investors typically require the debt to be rated. To issue a convertible, investors do not have a rating requirement. However, the investors will assign a credit spread assumption for the bond. Underwriter’s typically market these terms. But we often see deals that do not go well or go too well, depending on underwriter assumptions. Panthera begins the process by actually providing a credit rating on the security and determining an appropriate spread. By doing so, we are able to identify with management where we think the security will trade, which ultimately informs the reality of the ability to issue. Being prepared with unbiased advice in advance of a transaction prevents the situation where a management team may encounter significant push back from investors or stock pressure due to the need to have arb accounts involved to execute the deal. This can result in management being forced to go back to its pricing committee, explain why this has happened, and be forced with having to consider terminating the deal.

Furthermore, our ability to rate the security under the rubrics of the NRSRO’s informs management of their potential to consider other financing options, including high yield, or when to consider possibly tapping the high yield market, which guides the timing of any financing.