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A company life map - the rise and fall of a hot stock

Introduction| Course| 625

17. Convertible loan stock

Instead of issuing debenture stock, Country Bumpkin might have considered convertible loan stock as a means of raising money.

Convertible loan stock is stock that starts out as straightforward debt, but can be converted by the lender into equity.

• The loan is usually unsecured, which means that it is not tied to specific assets of the borrowing company. To this extent it is not as safe as debenture stock.
• As with debenture stock, it pays a fixed rate of interest and the principal amount of the loan has to be repaid by the company at a specified future date if the loan is not "converted" to equity.
• The key difference is that the lender has the option of converting the loan into equity at some stage of its life, and sometimes right from the outset.

Conversion terms are very specific. In Country Bumpkin's case, for instance, they might have said that every £4 of convertible loan stock could be converted by the lenders into one ordinary share at any time between 2000 and 2003.

• If, at the time of the issue, CB's share price was 300p, it would not make sense for the lenders to convert the loan stock into equity because they would be surrendering 400p of debt for 300p of equity.
• If CB's share price rises to 500p, then it would make sense to convert 400p of loan into 500p of equity.

In a sense, the holders of convertible loan stock can have their cake and eat it. They can keep the debt if the share price of the company is lower than the conversion price, or convert it to equity if there is a premium available.

But, note the twist to this tale: convertible loan stock is tradable itself, and the price of the stock will rise and fall in line with the company's share price.

Using the example above, if CB's share price rose to 500p - 100p higher than the conversion price of 400p - the value of the unconverted convertible loan stock would not stay at 400p but would rise to perhaps 450p.

Convertible loan stock can be an attractive option for companies because the rate of interest they have to pay on the loan is usually lower than for debenture stock.

As an alternative to raising money by issuing new shares it also has attractions because it is "deferred equity". In other words, the loan stock can be converted into equity but until it is converted, it isn't equity! And companies quite like this because their earnings per share (the critical performance measurement for the City) are not diluted.

1. Country Bumpkin - the early days 2. The decision to go public 3. AIM flotation by a placing of new shares 4. AIM flotation by an offer for sale 5. AIM flotation by tender offer 6. AIM flotation by introduction 7. First day of public trading on AIM 8. A growth strategy 9. End of lock-in period 10. The acquisition trail 11. Rights issue 12. Scrip issue 13. Preliminary results announced 14. Full results announced 15. Rumours of a deal - clarifying announcement 16. Takeover of rival - cash and shares deal 17. Convertible loan stock 18. Preparation for the main market 19. Admission to the main market 20. Move into FTSE 250 21. Share split 22. Share buyback 23. Director sells shares 24. New York-led collapse of tech stocks 25. Suspension of shares 26. Hostile bid for Country Bumpkin 27. Liquidation

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