Friday, 9 September 2016

"Death Spiral" Convertibles should be banned

Quite a few news articles in Singapore regarding "death spiral" comvertibles lately.

An interesting look in the kitchen of a company (Advance Capital) helpng to structure and issue those bonds can be found here:

"Singapore-based firm starts fund to buy 'death spiral' convertibles"

Some snippets:

The firm and its fund specialises in convertible bonds that have been called "death spiral convertibles" because of their dilutive impact on the underlying shares. Under Advance Capital's programme, a listed company that is in need of funds will issue to Advance Capital convertible notes that are convertible into new shares of the company at a fixed discount to the current market price. Because the notes set the conversion discount, and not the price, some notes have the potential to create a runaway negative impact on the underlying stock as each round of conversion gets even more dilutive.

Advance Capital has previously made such deals with Attilan Group (the former Asiasons Capital), Elektromotive Group, Yuuzoo Corp, Cacola Furniture International and OLS Enterprise. Other firms that are active in such programmes include Value Capital Asset Management, which has made deals with Annica Holdings, ISR Capital, Magnus Energy Group and LionGold Corp.

Advance Capital does not intend to hold the convertible bonds to maturity - Mr Ng told The Business Times that the bonds typically carry only a nominal coupon that is insufficient to cover the credit risk of the issuer. Instead, Advance Capital prefers to convert the notes into shares, and to sell the shares within a few days of conversion for a profit.

David Webb warned about these instruments already eleven years ago, some snippets (emphasis mine): has been aware of the toxic convertibles scam for many years and have repeatedly warned the regulators about them in private, urging a regulatory ban. In our view, there can be no logical reason why a listed company would want to cede control to a third party over what amounts to a stream of future equity issues at deep discounts to market. The Listing Rules should be amended to prohibit listed companies from issuing convertible instruments which carry floating conversion prices. We have waited until now to compile this article because we wanted to conduct a comprehensive study of the actual results of these deals, which can each last several years, to prove how damaging they are.

SGX's reaction:

"The company must send shareholders a circular written in plain English and without overly legalistic jargon, before the shareholder vote," Mr Tan wrote. "In it, the company must make clear to shareholders how such a bond could cause a downward spiral of the share price and result in massive dilutions detrimental to investors. The company must state the 'floor', or minimum conversion price and the maximum number of shares which could be issued on exercise." Directors must also give an opinion that the issuance is in the best interest of the company and shareholders, and "explain to shareholders the alternative sources of financing considered before arriving at the decision to issue the convertibles". SGX may reject applications to issue such instruments if disclosures do not meet those minimum standards. Beyond ensuring adequate disclosures, however, SGX is not in the business of assessing the merits of such convertibles, Mr Tan stressed. The instruments are ultimately a source of capital, the appropriateness of which is a commercial decision best left to companies and shareholders, Mr Tan stressed.

And with that we wholeheartedly disagree. SGX can stress the need for plain English in circulars, but who reads them anyway? How much chance realistically has a minority shareholder to overturn a proposal to issue these toxic bonds if the proposal is supported by the Board of Directors?

SGX should heed the advice of David Webb and simply ban convertible bonds which carry a floating conversion price by amending the listing rules.

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