This week has been another strong one for issuance, with over $4.2bn of new convertible bonds sold in the US, taking the year’s total to more than $33.2bn as of Thursday afternoon, according to Dealogic data.
Rallying stocks and sustained low interest rates have made it more attractive to issue convertible bonds, which have very low coupons and turn into cheap stock if an issuer’s share price rises above an agreed level, known as the strike price.
Over the past year the market has demonstrated extraordinary risk appetite through its willingness to lend billions to high growth technology businesses, which burn cash, and old economy issuers with businesses that have suffered in the pandemic. More than $100bn was issued in the US last year as companies rushed to raise financing following the onset of the pandemic. That compared to an average annual volume of $41.2bn in the five years from 2015 to 2019.
“Today, companies from resilient and recovery sectors like technology, communications services, and consumer discretionary are driving the charge, ahead of the expected economic recovery and a rebound in earnings,” said Venu Krishna, global head of equity-linked strategies at Barclays in New York. “We believe this surge still has legs as an ever-broader range of companies are likely to tap the convertibles market, viewing it as an increasingly viable source of cost-effective capital, and drawn by its widening size, liquidity, diverse issuer and investor base, and speed of access.”
Tech companies have again dominated the market this year, representing over half of total issuance, but a technology stock sell-off has led to the terms on their convertible bonds becoming less aggressive.
Companies can still achieve extraordinarily good pricing though, and there are signs that other kinds of issuers are becoming interested in the terms on offer in the convertible bond market.
This week, Ford Motor Company issued a $2bn convertible bond, one of the largest deals of the year so far. It achieved a zero coupon and a 40% premium on a stock which has already surged by more than 50% this year as a result of the company’s efforts to accelerate its transition to producing electric vehicles.
“Ford is not exactly the best issuer of you are ESG-centric,” said an equity-linked fund manager. “They are behind a lot in the race to produce electric vehicles, but the stock has rallied a long way and is now trading above where it was before Covid-19.”
It is the first time Ford has issued a convertible bond in over a decade.
Another $1.15bn convertible from sports betting company DraftKings was also priced with a zero coupon on Tuesday.
Recovery play
There have been numerous other smaller transactions over the past few days by other value companies, such as downstream energy firm South Jersey Industries, oil services company Oil States International, and Denver-based natural gas producer Centennial Resource Development.
Investors are happy to bet on these kinds of companies as they anticipate huge amounts of pent-up demand within the US economy once it begins to properly reopen later this year.
“You have the perfect conditions for the asset class to thrive,” said a second fund manager. “This year, most countries in the world will have positive GDP growth, which is really important. For the US in particular we are talking about close to 7% GDP growth this year — a massive rebound.
“You have inflation slowly coming back on track, and if we have a gradual interest rate hike when we get back to normality that is an ideal environment for equities and convertible bonds to perform historically,” he added. “That is why we are seeing massive activity in the primary market today.”