Industry profits from convertible strategy

By Paula Doe

WaferNews Contributing Editor

Stock prices may be down and loans hard to get, but semiconductor toolmakers are pulling in cash – and lots of it – from selling convertible bonds.

Teradyne ended up selling $400 million worth of its recent convertible bond issue, originally announced at $350 million. ASML took in $575 million, on its $500 million issue. All told, semiconductor equipment and materials suppliers have raised $3.2 billion from convertible bonds in the last six months.

The current environment of low interest rates and volatile stock prices is made to order for convertibles. Interest rates on convertibles are cheap, only 3 to 5%, compared to high yield bonds running 9 to 11%. And volatile stock prices may mean the issuer doesn’t have to dilute its stock as much as if issuing straight equity.

“You can price a fair amount of premium into the conversion option now,” points out Jeff Seidel, director of global convertible research at Credit Suisse First Boston.

Various recently issued convertibles from semiconductor toolmakers are priced to convert to equity if the stock goes up from anywhere from 30 to 185% over the next five years, effectively selling equity at higher future prices.

“The market is in a good position right now, and the good environment for new issues should continue through the end of the year, barring any new disasters,” says Seidel.

The convertible market stopped dead for about a month after Sept. 11, but things are hopping again. Since Sept. 11, companies have raised $12.1 billion in convertible debt, compared to only $3.5 billion from high yield bonds, $9.2 billion in syndicated bank loans to non-investment grade companies, and only $2.3 billion in initial public stock offerings. New issues to date in the US convertible universe are up 65% so far for the year, to $83.8 billion, raised in 163 deals, according to Morgan Stanley.

About 60% of that money went to companies with bond ratings below investment grade. The leading underwriter in the market was Merrill Lynch, with 25% share by issue proceeds, followed by Goldman Sachs, Salomon Smith Barney, Credit Suisse First Boston, and Morgan Stanley, all closely clumped with 12 to 15% share each.

The good news and the bad news is that it’s institutional investors, and specifically hedge funds, that are snapping up these new issues. Hedge funds account for about 65% of convertible bond purchases these days, according to Credit Suisse First Boston and Morgan Stanley.

These funds have attracted a lot of capital lately, have money to invest, and are a relatively new source of investment capital for the semiconductor equipment industry. But they’re investing it in the arbitrage strategy of buying convertible bonds and then selling short the stock, driving down the stock price down. That effectively limits convertible sales to better known companies with good prospects, which are well enough known so the bond issue can be all sold in as short a time possible, usually overnight or intraday, to protect the stock from short selling.

“The more obscure the equity story, the harder the sell,” notes Seidel.

“It’s not for everybody. You have to have a solid history to do a convertible,” points out Richard Beck, CFO of Advanced Energy Resources. He notes that Advanced Energy’s convertible issue went 45% to hedge funds, 55% to institutional investors, and the company’s stock went down 12% immediately afterwards, although the Federal Reserve also reduced interest rates less than expected that day. Still, he figures the convertible was the best option available. “If we could,” he jokes, “we’d become a nonprofit institution and people would just donate money.”



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