High-growth companies stand poised to continue a rush into convertible and other equity-linked securities, suggesting some strain in the stock market. Broadcom Inc, Akamai Technologies Inc, Snap Inc and Tesla Inc all tapped the niche corner of capital-raising in 2019, inking deals over $1bn in an attempt to secure attractive terms while the market at all-time highs still allowed for it.
Equity-linked volume which include convertible, mandatory and preferred issues, climbed for the second consecutive year, hitting a post-financial crisis record of more than $55bn.
Bankers say the 2020 haul could be just as cushy, though the election could make for an off-kilter year. “We may set another record, but there won’t be a massive uptick in issuance,” said Steven Halperin, Barclays head of Americas equity-linked and hybrid solutions.
And that’s assuming rates don’t move and the stock market continues to do what it has, stay at highs or at least near them, as predicted by Barclays Research.
High-growth companies with speculative credit profiles in technology, communications and health care have dominated the convertible landscape as investment-grade companies have sought relatively better financing options elsewhere in an era of low interest rates.
From 2000 to 2004, investment-grade deals accounted for nearly half of issuance volume, but have since dwindled to just 5% of total volumes between 2015 and 2019, according to JPMorgan. In the past two years, over 80% of convertible issuance came from unrated companies, 12% from junk-rated issuers, and the balance from investment grade, according to Barclays.
Halperin sees 2020 activity resembling this year’s, with growth of around 10%. Growth companies appear to have invoked the old adage – raise money when you can, not when you need. Terms have enticed them, with sub-1% coupons and 35% conversion premiums, the amount the stock needs to climb for an embedded option to come into play.
“Many companies didn’t need the money, but wanted to be potential acquirers should rivals falter,” Osterweis Capital Management Portfolio Manager Craig Manchuck said. It’s an attractive deal when stocks are sitting pretty. Companies had motivation, citing “general corporate purposes,” said RBC Capital Markets’ Suvir Thadani.
“They’re in effect saying: I have a cash balance, but I don’t know what the future holds, so let me raise more capital.” Like the stock market, price performance has been strong in 2019, with both major convertible indexes on the upswing.
US Convertible index rose 22% year-to-date compared to the S&P 500 and Russell 2000 Growth index’s 28% gain.
Full Looking ahead, election years have not favoured convertibles. Equity-linked issuance shrank to post-crisis lows in 2012 and 2016 with $25bn and $35bn in volumes, respectively.
The momentum behind equity-linked products and the looming election could make for a manic year. Some expect the second half of the year to be turbulent, said Santosh Sreenivasan, JPMorgan’s head of equity-linked products. That fear, and perhaps the urgency to raise capital before a potential drop-off, could result in a first-half surge.
Sreenivasan expects recent momentum behind convertibles to continue through the first half at least. Osterweis’ Manchuck echoed Sreenivasan. The companies that want or need the capital are likely going to want to tap the market before investor reticence kicks in, he said.
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