The Convertible Makes a Comeback
ADC Telecommunications Inc. (Nasdaq: ADCT) and Lucent Technologies Inc. (NYSE: LU) are the latest telecom suppliers to take advantage of improved prospects in the corporate bond and stock markets to give their finances a boost (see ADC Prices Notes and Lucent Raises $1.5B).
Both companies today unveiled issues of convertible notes designed to raise money from investors. The offers follow news earlier this week of a similar offer from Juniper Networks Inc. (Nasdaq: JNPR) (see Juniper's Bullish Conversion).
With the stock market and corporate bond markets percolating again, it looks as if convertibles have become the financing weapon of choice for institutional investors looking to play the potential rebounds in the networking sector. What's driving the interest? Well, a hint may be gathered from a glance at the Light Reading Index, which is up 36 percent in 2003.
"The bearish can say companies are using this latest great run on the market to raise funds on converts... Others could say the market's up and investors are now willing to give companies money. I'm sort of in between," says Grange Johnson, general partner at LaGrange Capital Partners LP.
Indeed, a convertible's value to an investor is a sticky proposition. Like a corporate bond, some of them pay interest -- though at a substantially lower rate. They also function as on option on common stock -- if the stock price rises to the conversion price the investor captures the premium.
In ADC's and Lucent's cases, there's the chance to gain interest on the notes before conversion. ADC, for instance, is offering one set of notes worth $175 million, due in 2008 with an interest rate of 1.00 percent annually. The notes can be converted into ADC common shares at $4.013 per share -- a 52 percent premium over the company's stock price on May 29, when the offer was announced.
Table 1: Recent Telecom Vendor Convertibles
|Total raised or projected||Maturity and interest terms||Conversion terms|
|ADC||Up to $400 million||$175 million due 2008; 1.00% annual interest||$4.013 per share redeemable anytime prior to maturity|
|$175 million due 2013; interest at six month LIBOR* plus .375%||$4.013 per share redeemable anytime prior to maturity|
|Juniper||$350 million||All notes due 2008||$20.14 per share redeemable subject to specified events|
|Lucent||$1.525 billion||Series 1 due 2023; 2.75% annual interest||$3.34 per share redeemable 2010, 2015, 2020|
|Series 2 due 2025; 2.75% annual interest||$3.12 per share redeemable 2013, 2019|
|* London Interbank Offered Rate |
Source: Company statements
The offerings raise a bunch of questions. First: How much is being raised? ADC says it's planning to garner up to $400 million; Lucent says it has raised $1.525 billion; and Juniper's offering should glean it $350 million.
Where is all that money going? Lucent's reasons for its offer are distinctly unromantic -- to improve the balance sheet and pay bills. But ADC's press release clearly indicates it plans to use the proceeds in part for "strategic opportunities, including financing for possible acquisitions or investments in complementary businesses, technologies or products."
Do the convertibles signal good news about the underlying economy, particularly the telecom sector?
Sort of, experts say. On one hand, the fact that investors are willing to pony up for convertibles is a signal of renewed vigor in the securities markets. On the other, more cynical observers caution against making too much of the surge.
A look on the bright side first: "A couple of factors are pointing to stabilization," says Ari Bensinger at Standard & Poor’s. Network utilization rates for carriers are creeping to the 70 percent range in larger metro areas, he notes, the traditional point at which renewed spending on infrastructure occurs. What's more, the ratio of carrier capex to sales is "in the mid-teens," signaling a healthier balance for key telecom buyers.
Now, consider the negatives: Bensinger says carrier capex estimates signal that, at the best, growth in telecom will remain in the single-digit range for the foreseeable future. Convertibles can therefore be viewed as a way companies are tapping spurts of market growth to improve their balance sheets -- while hedging their bets in case the downturn lasts longer than expected. After all, in the best of worlds, companies would be flush with cash from public trading and able to raise money in other ways.
Bensinger also notes that we've been here before: Companies like Lucent have routinely turned to convertibles for cash when there was little or no sign of a macro upturn (see Riverstone Offers Notes, Nortel Amends Offering, Lucent Raises $1.75B, and Corning Makes Stock Offering).
This rash of convertibles does appear be a bit different from past ones. In the background, companies are quietly striking related deals that seem to indicate a stronger market. As part of its offering, Lucent, for instance, has been able to secure new credit of $595 million against guarantees of refunds it extends to customers as a routine part of contracting work. And ADC plans to use part of the proceeds of its offer to buy back notes in order to avoid diluting the pool of shares -- certainly a tack that indicates a company's confidence in its future.
— Mary Jander, Senior Editor, Light Reading