Bonding with convertibles

No I am not talking about sexy Alfa Romeos here.

Falling stock prices mean that investors have to increasingly rely on the bond part of the convertible securities for returns.

More than $1.4 trillion of equities worldwide are now on loan, about a third higher than at the start of 2007, data compiled by Spitalfields Advisors, the London-based firm specialising in securities lending, show. Almost all of that is being used to speculate shares will fall, according to James Angel, a professor at Georgetown University who studies short-selling.

Negative Yields Investors were willing to accept negative yields of as much as 11.5 percent in January to buy Reliance Communications Ltd.’s zero-coupon convertible bonds maturing in 2011, as the company’s share price on Jan. 9 climbed to a record 821.55 rupees, 71 percent higher than the 480.68 rupee conversion price set when the $500 million of securities were sold in March, 2006.

Investors are now asking for more than 5 percent yield to buy the bonds of the Mumbai-based company, India’s second-largest mobile-phone operator, as the stock has fallen 48 percent from its record, according to Nomura Holdings Inc.’s prices.

“This market is becoming a busted universe, offering little equity value,’’ as a HK based analyst Viktor Hjort said. “As stock markets are repriced, people should treat the share option portion of a convertible bond just as a lottery ticket and start looking at the asset from pure credit fundamental perspective.’’

But then there are many other wide open, lucrative avenues for ever enterprising investment funds.

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Tata Ste(a)l deal

In the midst of sub prime mortgage woes, there’s been little interest for bonds and CDOs. Even in such a scenario, when Tata Steel has managed to raise $725 million through foreign currency convertible alternative reference securities (CARS), which was oversubscribed by more than two times. There is a greenshoe option of $150 million, which has not yet been exercised.

Tatas have always been an excellent credit risk. Yet, I was a bit curious about its timing and even more about the structure of this bond.

The CARS will be convertible at an initial conversion price of Rs 876.6225 a share, which is at a premium of 35 per cent to the company’s closing share price on the National Stock Exchange of India as on August 6, 2007.

The CARS carry a 1 per cent coupon and the effective YTM is 5.15 per cent. The outstanding CARS, if any, at maturity will be redeemable at a premium of 23.3419 per cent of the principal amount.

Current 3M Libor is 5.36%. Considering this Tatas got a fair deal as it’s long term money. The redemption premium of 23.34% on outstanding CARS must have been alluring to the lenders but when you factor in an asset like Corus in its bag, Tata Steel stock have only one way to go – up. Hence conversion is almost a given and question of outstanding CARS may not arise.

I wouldn’t rule out a buyback initiative by TATAs close to conversion or maturity (not known now), knowing their preference against dilution of controlling stakes. Call it Tata Steel deal now, closer to maturity don’t be surprised if it looks like a Tata Ste(a)l…

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