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Risky technology groups are rushing to raise cheap cash on the convertible bond market while investor enthusiasm about artificial intelligence fuels a surge in their stock prices.
US companies have raised roughly $7.4bn through such debt in February, according to data from LSEG, the highest monthly figure since August, with tech and fintech groups accounting for three-quarters of the total. Last week was the busiest in a year for sales of so-called convertibles.
The Federal Reserve has been holding its benchmark interest rate at a 22-year high since July, but borrowers in convertible markets have been able to raise funds at much lower interest rates with relatively few restrictions on how they spend them.
“A frothy market, particularly on the equity side, will present an opportunity for many companies to access a free lunch,” said John McClain, a portfolio manager at Brandywine Global Investments. “Converts are open for business.”
Convertible bonds are a type of debt that initially pays interest like a regular bond but are exchanged for stock if the issuer’s share price rises to a certain level. By offering the additional upside potential of a conversion to stock, companies can borrow at a lower interest rate.
Issuance tends to jump when stock market valuations are high. If a company believes its stock is overvalued and unlikely to keep climbing, then a convert allows it to borrow at a lower interest rate without much risk of having to issue new shares. If the stock does continue to rise, the high valuation means the dilution of existing investors would be relatively low.
Rising volumes last year were helped by a substantial increase in fundraising by high-grade companies that traditionally would have borrowed through conventional corporate bonds. The latest spate of activity, however, has included riskier names that some investors have compared to the frothy markets of 2020 to 2021.
Super Micro Computer, a server equipment maker with no credit rating whose share price has more than doubled since the start of the year, was able to raise $1.7bn with zero interest rate.
Lyft, the ride-hailing company, raised $460mn the week after its financial results prompted a 35 per cent share price rally. The new bond pays a lower coupon than a previous convertible that it issued in 2020, when interest rates were close to zero.
Both deals were heavily oversubscribed, despite the low interest rates on offer.
“I think it feels very much like the end of 2020, beginning of 2021 in the equity market as well as the convertible market following suit,” said McClain.
Bryan Goldstein, an adviser at Matthews South who worked on Lyft’s fundraising, said recent activity was similar to 2021 in that record-high share prices were encouraging opportunistic deals by companies that do not have impending funding pressures. The S&P 500 has hit multiple record highs over the past month, while the tech-dominated Nasdaq Composite was within touching distance of its own record this week.
According to Michael Youngworth, a convertible bond strategist at Bank of America, a slower than expected fall in inflation is also encouraging companies to issue debt sooner rather than later.
“Recent hot economic data and repriced rates expectations have suggested to the market that rates are likely to remain higher for longer . . . [so] there’s little benefit to waiting to refinance,” he said.
However, Goldstein and Youngworth said most investors were still being more cautious than at the height of the previous boom. “There is pent-up investor demand . . . [and] the market has been very constructive, but they’re wary of being hyper-aggressive,” Goldstein said.
In 2021, many companies issued bonds that paid zero interest and would only convert to stock if the company’s share price increased by more than 50 per cent. In one of the more extreme cases, Airbnb borrowed with a so-called conversion premium of more than 70 per cent. This month, in contrast, premia have been closer to historic average ranges of 25 per cent to 30 per cent.
