Mar 5, 2024 - Business

Why strong stocks are helping some companies issue bonds

Data: BofA Global Research; Chart: Axios Visuals
Data: BofA Global Research; Chart: Axios Visuals

In an era of expensive money, you look for deals. And they're happening in the convertible bond market.

The big picture: For most of the last decade, convertible bond issuance has been dominated by earlier-stage growth companies with no credit ratings — a backdoor way to raise equity and establish credit market history at the same time.

Yes, but: Large, well-established companies that boast investment-grade (IG) credit ratings increasingly want in on that cheap money — and a record share of 2023's convert deals were issued by IG companies.

Why it matters: It's another example of how the high-rate environment is reshaping borrowing habits and business plans.

  • "We've seen a lot of names that might otherwise do a traditional bond, come to the convert space to save precious points on their coupon," says Michael Youngworth, head of global convertibles and preferreds strategy at BofA Global Research.

How it works: Converts have low coupons since they offer investors the option of converting into stock, if the company's shares hit a pre-determined price.

  • Up until last year, the most creditworthy companies were far less likely to tap this market, since they could borrow cheaply in the regular-way debt market and avoid equity dilution.
  • But in today's market — strong stock prices weighed against expensive borrowing costs — that tradeoff is shifting.

For example: Global Payments, an IG-rated payments technology company with a $34 billion market cap that's been public since 2001, placed a $2 billion convertible bond last month — with a 1.5% coupon.

  • In comparison, the company's existing senior notes yield about 5.5% — a proxy for how much it would have to pay if issued regular old bonds.
  • "A few years back, we wouldn't have seen Global Payments come to the convert market," says David Clott, portfolio manager at Wellesley Asset Management, which specializes in convertibles.
  • Indeed, in 2021, with rates at rock-bottom levels, Global Payments was issuing regular IG bonds with coupons under 3% — there was no urgency to seek out a cheaper cost of capital.

State of play: About 26% of convertible deals in 2023 were for IG-rated companies, up from 7% the year before, and just 2% in 2021.

  • So far in 2024, the share is about the same as last year, Youngworth says.
  • "This suggests a more mature and higher-quality set of issuers — especially compared to the young and opportunistic names that drove the pandemic-era boom," wrote Youngworth in a report.

What we're watching: With rates expected to stay somewhat higher for longer, the trend will likely continue, says Clott.

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