An interesting article from the Wall Street Journal on floorless convertibles.
What really grabbed my attention was "...newest transaction is a $100 million to $150 million private placement for a New York Stock Exchange-listed distribution company with more than $10 billion in annual sales...."
Any idea who that might be?
Here's the article:
interactive.wsj.com
September 28, 1998
'Toxic Convertible' Can Be
Risky Rescuer for Needy Firms
By AARON LUCCHETTI and LESLIE SCISM
Staff Reporters of THE WALL STREET JOURNAL
It comes down to the need for growth.
Small companies desperate to fund growth plans are
increasingly turning to a convenient but potentially risky
form of financing. An unusual type of convertible preferred
shares, known as "death spirals" and "toxic convertibles" to
critics, is attracting interest from small companies, and a
few larger ones, who need money and feel they have
nowhere else to turn.
The market's turbulence over the past few months has
triggered new interest in these complex securities, which
have a floating conversion ratio, even though some
companies using this financing have seen their share prices
demolished. "It wasn't optimal, but given our circumstances,
we believe it was the best option," says Edward Laves, chief
executive officer at Illinois Superconductor, a
telecommunications-equipment company whose stock has
fallen more than 80% since it raised $9.5 million through a
convertible-preferred-share placement in 1997.
He says he isn't sure the company could have survived
without using the convertibles. After the Mount Prospect,
Ill., company's secondary public offering was pulled amid
weak demand, "we were down to a few weeks of cash," he
says.
Investor Lawsuit Filed
But some shareholders don't agree. In June, one investor
filed a lawsuit seeking class-action status against company
officials. The complaint, filed in Illinois state court in
Chicago, alleges the 1997 financing depressed the share price
and cost the company's investors $61 million.
Critics of the convertible-preferred transactions say the
dilution in the stock's value results from the way the deals
are structured. In these private-placement financings,
companies receive a set amount of money, usually from new
investors. In return, the new investors get preferred shares
that eventually can be converted into an unspecified number
of newly issued common shares. The number of new
common shares distributed varies with the stock price.
When the common-stock price moves higher, few are
unhappy. But problems arise when the stock falls. Then, as
new investors convert their preferred shares at a lower price,
the company is forced to issue more and more common
shares to pay them back, driving the stock price down
further. Short sellers make the situation worse. These
investors, who bet on downward moves in stock prices, have
found companies that do this type of convertible transaction
an easy target for profits. To short sellers, "toxic convertibles
are a red flag" that a company might have problems and is
using a financing tool of last resort, says Morton Cohen, a
hedge-fund manager with Clarion Partners in Cleveland.
Still, more companies are looking into these
convertible-preferred placements, mainly because as the
market's volatility builds and investors grow more cautious,
it is harder to raise money in other ways. Analysts estimate
that companies raise more than $1 billion a year through
the financing technique, which gained popularity in the
mid-1990s.
Boom Seen
Cappello Group, a Santa Monica, Calif., firm specializing in
floating-price convertible deals, says it has seen a boom in
the securities at both larger and smaller companies. "This
type of transaction makes a lot of sense in the kind of
market we're seeing right now," says J. Kenneth Marek, vice
president of a Cappello affiliate. Mr. Marek says the firm has
about 30 convertible "future-priced" deals in the pipeline,
up from a normal flow of about seven to 10 at a given time.
Cappello's newest transaction is a $100 million to $150
million private placement for a New York Stock
Exchange-listed distribution company with more than $10
billion in annual sales, which Alexander Cappello,
chairman, won't identify further until the transaction's
expected close later this week. According to Mr. Cappello,
many managements believe their share prices are too low to
issue stock or a conventional preferred security, which locks
in a value for the shares near current market value.
Meanwhile, regulators at the National Association of
Securities Dealers are examining whether more-stringent
risk disclosure should be applied when companies turn to this
type of convertible-preferred-stock financing. "A couple of
companies got hit pretty hard with these securities, so we
began to look more closely," says David Irwin, head of listing
qualifications at the NASD's Nasdaq Stock Market.
Specifically, Nasdaq is considering restrictions on the
securities' structure intended to protect shareholders by
limiting the possible dilution.
Already, Nasdaq requires shareholder votes before many
convertible-preferred-securities transactions can proceed.
This spring, Nasdaq persuaded TranSwitch, a
semiconductor-equipment maker in Shelton, Conn., to
insert a clause into its $14.5 million
convertible-preferred-financing deal that would protect its
shareholders from dilution.
Problems Continue
But problems still arise. In June, Able Telcom Holding, a
West Palm Beach, Fla., communications-networks concern,
used convertible-preferred financing to help pay for an
acquisition. As word of the deal spread, short interest (shares
sold short and not yet repurchased) increased sixfold to more
than two million shares. Friday, Able closed at 4 5/8, down
75% from the transaction date.
Able officials didn't return calls for comment. But firms
that specialize in arranging the convertible-preferred deals
for small companies, such as Palladin Group, which
participated in the Able Telcom deal, and Cappello say they
institute safeguards for companies. For one, the
preferred-stock investors often are banned from selling the
stock short. And in some deals, companies are allowed to
substitute a cash payment for common-stock issuances
made dilutive by a share-price decline.
While ten of 11 companies that used the convertible
securities at Cappello have seen their common-stock prices
drop, including restaurant chain Koo Koo Roo, mining
company Casmyn and biopharmaceutical concern OraVax,
Cappello officials maintain the downward pressure wasn't
caused by the financing. Instead, Cappello's Mr. Marek says,
the share-price declines are a result of the companies'
strategies and performance.
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