By Chantal Marx & Jalpa Bhoolia.
What is a convertible bond?
A convertible bond is a debt security that provides investors with an option to convert or exchange their bonds for a specific number of shares in the issuing company at a predetermined ratio. Convertible bonds are typically issued at a slightly lower interest rate; however, they act just like the corporate bonds of the issuing company. The reason for the lower interest rate is because there is value in holding the option to convert the bond into a stock, and like all investments, there is a risk and return trade-off.
There are two types of convertible bonds:
Why do companies issue convertible bonds?
There are several reasons why a company would issue convertible bonds:
The Sibanye Stillwater convertible bond issue
On Tuesday, 21 November, Sibanye-Stillwater (SSW) announced that Stillwater Mining Company (a wholly-owned subsidiary of SSW) launched an offering of $500 million in senior unsecured guaranteed convertible bonds due November 2028. The results of the offer were published after market close.
When announcing a convertible bond issue, a company's share price could come under pressure due to the potential future dilution of ordinary shareholders as well as some other factors like the conversion ratio and hedging activity by the issuer and/or the convertible bond holders.
The share price reacted violently to the offer announcement, losing over 20% on the day, which seems like an outsized reaction given the possible maximum dilution of 13.7% over five years (this bond can be redeemed early by the company). We believe there was some hedging activity in the market that resulted in the large decline in the share price. The pricing of the bond ended up coming in at the middle of management expectations (4.25% coupon, conversion price: 32.5% premium to yesterday's VWAP). The leadership team also noted in the aftermarket pricing announcement that the offer was multiple times oversubscribed.
The company likely opted for a convertible bond issue as the share price may have been too depressed to consider an equity capital range, and it did not have the constitution in the current low commodity price environment to raise vanilla debt.
The proceeds will be used to fund the groups growth strategy, including the Reldan acquisition announced on 9 November 2023, and propping up the balance sheet amid a low commodity price environment.
Sibanye-Stillwater is pursuing an expansion strategy that is out of kilter with the rest of the sector where the focus is on cash returns to shareholders. This signals management's intent to continue growing the business but adds execution risk to the name. The share price reaction yesterday is regarded as overdone and, while our longer-term preference is for Northam and Amplats in the sector, we see near-term upside in the share price.
