US technology companies have issued gobs of convertible debt or “converts” in recent years. These securities are starting to come due, putting the companies in a bind. Eleven tech organizations have converts maturing in the next 16 months, and their stocks are trading below the conversion prices. That means they’ll probably have to pay the debt off or refinance it. But the former would drain precious cash, while the latter is absurdly expensive.
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For years, the match seemed perfect. Companies ranging from memory giant Micron Technology Inc. to niche chip maker Anadigics Inc. needed cash upfront to develop products. Because they had few assets to offer as collateral, conventional debt was often too expensive. But tech companies could promise future profits, and their stocks are typically volatile. Those factors make the options embedded in a convert valuable, so the companies could issue them with low interest rates. Meanwhile, a whole slew of hedge funds started trading converts, so demand wasn’t a problem.
This is no longer the case. The recent ban on shorting financial stocks severely wounded many convertible arbitrage funds. Since they previously accounted for as much as 70% of demand for these securities, tech companies will find it hard to refinance their maturing converts.
This leaves them in a pickle. Nearly all have stocks that are nowhere near their conversion price. Take Rambus Inc. The California-based chip technology firm has $160 million (Rs808 crore) of convertible debt coming due at the beginning of 2010. The company’s stock would need to more than triple for the convert’s option to be in the money. The company does have $378 million in cash on hand, but its operations have lost money for four consecutive quarters.
For many tech companies, the alternatives are unpalatable. They can issue debt, but because tech companies typically have dreadful ratings and little collateral, the cost is often prohibitive. They don’t want to issue stock at currently depressed prices. Some are buying back their converts, often at a discount— but prices can shoot up when investors realize the issuer has its back to the wall. A company can try to raise cash by selling assets, but again, it faces a depressed market where buyers will attempt to profit from its woes. Or, a firm could put itself on the block in its entirety. Even if current prices appear low, acting soon may make sense since shareholders could dump stock and potential buyers offer less as financing deadlines approach.
Many tech companies appear to be hunkering down as best they can by cutting costs and selling assets. Unfortunately, signs that technology demand fell sharply in October means these stopgap measures probably won’t work for long. If conditions don’t improve, maturing convertibles may push these companies into suitors’ arms—or over the edge.