AI hype spurs convertible bond revival

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Super Micro Computer shares are up more than 4,000 per cent in the past five years. What is the chance they can rally another 37.5 per cent in the next five? The US company makes data centre equipment that has proved useful in the artificial intelligence computing boom. Its market capitalisation has reached almost $50bn and annual fiscal revenue this year is expected to double to around $15bn.

But the company’s working capital needs have also become substantial. It needs short-term cash. Enter a suddenly hot convertible bond market. Super Micro recently sold $1.5bn of this hybrid debt, which includes the ability for holders to convert their notes into equity. All Super Micro shares have to do is rise by 37.5 per cent for that option to be in the money. 

Several companies, including the likes of Lyft and Global Payments, have tapped convertible bonds in recent weeks. The rush pushed issuance in February back towards the peaks of last year. But given the high interest rate backdrop, only AI high flyer Super Micro could price at zero, meaning it avoids even a modest coupon payment.

During the 2020/2021 convertible bond boom, several splashy growth companies including Beyond Meat and Peloton were able to sell convertibles without coupon obligations. As a portent of caution, many never came close to reaching the premiums necessary for the equity to be profitably convertible.

Buyers of convertible bonds are typically specialised hedge funds. They have strategies around purchasing the bonds and selling the underlying stock short in order to lock in small, risk-free returns. A volatile stock is helpful as it increases the theoretical value of the equity option. Coupons on convertibles are perhaps in the 1 to 4 per cent range, given the attached equity option. 

With a zero per cent coupon the investor is not being compensated even with token cash payments for holding the bond. That leaves the company in effect selling only equity at a higher price than its current trading value. Super Micro executives told investors recently they were very focused on both raising cash and attempting to minimise dilution. 

Shares of Super Micro are down a tenth since the time of the convertible offering last week. That is disappointing for the company. But there is a silver lining: the $1.5bn of cash that it raised in the deal is, for now, in effect free money.